NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH
31, 2017 (UNAUDITED) AND DECEMBER 31, 2016
1.
ORGANIZATION AND DESCRIPTION OF BUSINESS
China
Recycling Energy Corporation (the “Company” or “CREG”) was incorporated on May 8, 1980 as Boulder Brewing
Company under the laws of the State of Colorado. On September 6, 2001, the Company changed its state of incorporation to the State
of Nevada. In 2004, the Company changed its name from Boulder Brewing Company to China Digital Wireless, Inc. and on March 8,
2007, again changed its name from China Digital Wireless, Inc. to its current name, China Recycling Energy Corporation. The Company,
through its subsidiaries, provides energy saving solutions and services, including selling and leasing energy saving systems and
equipment to customers, project investment, investment management, economic information consulting, technical services, financial
leasing, purchase of financial leasing assets, disposal and repair of financial leasing assets, consulting and ensuring of financial
leasing transactions in the Peoples Republic of China (“PRC”).
Erdos
TCH – Joint Venture
On April 14, 2009, the Company
formed a joint venture (the “JV”) with Erdos Metallurgy Co., Ltd. (“Erdos”) to recycle waste heat from
Erdos’ metal refining plants to generate power and steam to be sold back to Erdos. The name of the JV was Inner Mongolia
Erdos TCH Energy Saving Development Co., Ltd. (“Erdos TCH”) with a term of 20 years. Total investment for the project
was estimated at $79 million (RMB 500 million) with an initial investment of $17.55 million (RMB 120 million). Erdos contributed
7% of the total investment of the project, and Xi’an TCH Energy Technology Co., Ltd. (“Xi’an TCH”) contributed
93%. According to the parties’ agreement on profit distribution, Xi’an TCH and Erdos will receive 80% and 20%, respectively,
of the profit from the JV until Xi’an TCH receives the complete return of its investment. Xi’an TCH and Erdos will
then receive 60% and 40%, respectively, of the profit from the JV. On June 15, 2013, Xi’an TCH and Erdos entered into a
share transfer agreement, pursuant to which Erdos transferred and sold its 7% ownership interest in the JV to Xi’an TCH
for $1.29 million (RMB 8 million), plus certain accumulated profits as described below. Xi’an TCH paid the $1.29 million
in July 2013 and, as a result, became the sole stockholder of the JV. In addition, Xi’an TCH paid Erdos accumulated profits
from inception up to June 30, 2013 in accordance with a supplementary agreement entered on August 6, 2013. In August 2013, Xi’an
TCH paid 20% of the accumulated profit (calculated under PRC GAAP) of $226,000 to Erdos. Erdos TCH currently has two power generation
systems in Phase I with a total of 18MW power capacity, and three power generation systems in Phase II with a total of 27MW power
capacity. On April 28, 2016, Erdos TCH and Erdos entered a supplemental agreement, effective on May 1, 2016, Erdos TCH cancelled
monthly minimum lease payments from Erdos, and charges Erdos based on actual electricity sold at RMB 0.30 / Kwh. The selling price
of each Kwh will be determined annually based on market condition.
Pucheng
Biomass Power Generation Projects
On
June 29, 2010, Xi’an TCH entered into a Biomass Power Generation (“BMPG”) Project Lease Agreement with PuchengXinHeng
Yuan Biomass Power Generation Co., Ltd. (“Pucheng”), a limited liability company incorporated in China. Under this
lease agreement, Xi’an TCH leased a set of 12MW BMPG systems to Pucheng at a minimum of $279,400 (RMB 1,900,000) per month
for 15 years.
On
September 11, 2013, Xi’an TCH entered into a BMPG Asset Transfer Agreement (the “Pucheng Transfer Agreement”)
with Pucheng. The Pucheng Transfer Agreement provided for the sale by Pucheng to Xi’an TCH of a set of 12MW BMPG systems
with completion of system transformation for RMB 100 million ($16.48 million) in the form of 8,766,547 shares of common stock
of the Company at the price of $1.87 per share. These shares were issued to Pucheng on October 29, 2013. Also on September 11,
2013, Xi’an TCH entered into a BMPG Project Lease Agreement with Pucheng (the “Pucheng Lease”). Under the Pucheng
Lease, Xi’an TCH leases this same set of 12MW BMPG system to Pucheng, and combined this lease with the lease for the 12MW
BMPG station of Pucheng Phase I project, under a single lease to Pucheng for RMB 3.8 million ($0.63 million) per month (the “Pucheng
Phase II Project”). The term for the combined lease is from September 2013 to June 2025. The lease agreement for the 12MW
station from Pucheng Phase I project terminated upon the effective date of the Pucheng Lease. The ownership of two 12 MW BMPG
systems will transfer to Pucheng at no additional charge when the Pucheng Lease expires.
Shenqiu
Yuneng Biomass Power Generation Projects
On
May 25, 2011, Xi’an TCH entered into a Letter of Intent with ShenqiuYuNeng Thermal Power Co., Ltd. (“Shenqiu”)
to reconstruct and transform a Thermal Power Generation System owned by Shenqiu into a 75T/H BMPG System for $3.57 million (RMB
22.5 million). The project commenced in June 2011 and was completed in the third quarter of 2011. On September 28, 2011, Xi’an
TCH entered into a BMPG Asset Transfer Agreement with Shenqiu (the “Shenqiu Transfer Agreement”). Pursuant to the
Shenqiu Transfer Agreement, Shenqiu sold Xi’an TCH a set of 12 MW BMPG systems (after Xi’an TCH converted the system
for BMPG purposes). As consideration for the BMPG systems, Xi’an TCH agreed to pay Shenqiu $10,937,500 (RMB 70 million)
in cash in three installments within six months upon the transfer of ownership of the systems. By the end of 2012, all of the
consideration was paid. On September 28, 2011, Xi’an TCH and Shenqiu also entered into a BMPG Project Lease Agreement (the
“2011 Shenqiu Lease”). Under the 2011 Shenqiu Lease, Xi’an TCH agreed to lease a set of 12MW BMPG systems to
Shenqiu at a monthly rental rate of $286,000 (RMB 1,800,000) for 11 years. Upon expiration of the 2011 Shenqiu Lease, ownership
of this system will transfer from Xi’an TCH to Shenqiu at no additional cost. In connection with the 2011 Shenqiu Lease,
Shenqiu paid one month’s rent as a security deposit to Xi’an TCH, in addition to providing personal guarantees.
On
October 8, 2012, Xi’an TCH entered into a Letter of Intent for technical reformation of Shenqiu Project Phase II with Shenqiu
for technical reformation to enlarge the capacity of the Shenqiu Project Phase I (the “Shenqiu Phase II Project”).
The technical reformation involved the construction of another 12MW BMPG system. After the reformation, the generation capacity
of the power plant increased to 24MW. The project commenced on October 25, 2012 and was completed during the first quarter of
2013. The total cost of the project was $11.1 million (RMB 68 million). On March 30, 2013, Xi’an TCH and Shenqiu entered
into a BMPG Project Lease Agreement (the “2013 Shenqiu Lease”). Under the 2013 Shenqiu Lease, Xi’an TCH agreed
to lease the second set of 12MW BMPG systems to Shenqiu for $239,000 (RMB 1.5 million) per month for 9.5 years. When the 2013
Shenqiu Lease expires, ownership of this system will transfer from Xi’an TCH to Shenqiu at no additional cost.
Yida
Coke Oven Gas Power Generation Projects
On
June 28, 2014, Xi’an TCH entered into an Asset Transfer Agreement (the “Transfer Agreement”) with Qitaihe City
Boli Yida Coal Selection Co., Ltd. (“Yida”), a limited liability company incorporated in China. The Transfer Agreement
provided for the sale to Xi’an TCH of a 15 MW coke oven gas power generation station, which had been converted from a 15
MW coal gangue power generation station from Yida. As consideration for the Transfer Asset, Xi’an TCH was to pay to Yida
RMB 115 million ($18.69 million) in the form of the common stock shares of the Company at the average closing price per share
of the Stock for the 10 trading days prior to the closing date of the transaction ($2.27 per share). The exchange rate between
the US Dollar and Chinese RMB in connection with the stock issuance is the rate equal to the middle rate published by the People’s
Bank of China on the closing date of the assets transfer. Accordingly, the Company issued 8,233,779 shares (the “Shares”)
for the Yida 15 MW coke oven gas power generation station, the fair value of 8,233,779 shares was $14.49 million based on the
stock price at agreement date ($1.76 per share), and was the cost of the power generation station.
On
June 28, 2014, Xi’an TCH also entered into a Coke Oven Gas Power Generation Project Lease Agreement (the “Lease Agreement”)
with Yida. Under the Lease Agreement, Xi’an TCH leased the Transfer Asset to Yida for RMB 3 million ($0.49 million) per
month, and the term of the lease is from June 28, 2014 to June 27, 2029. Yida provided an RMB 3 million ($0.49 million) security
deposit (without interest) for the lease. Xi’an TCH will transfer the Transfer Asset back to Yida at no cost at the end
of the lease term.
On
June 22, 2016, Xi’an TCH entered into a Coal Oven Gas Power Generation Project Repurchase Agreement (the “Repurchase
Agreement”) with Yida. Under the Repurchase Agreement, Xi’an TCH agreed to transfer to Yida all the project assets
for RMB 112,000,000 ($16.89 million) (the “Transfer Price”) with Yida’s retention of ownership of the Shares.
Yida agreed to make the following payments: (i) the outstanding monthly leasing fees for April and May 2016 in total of RMB 6,000,000
($0.90 million) to Xi’an TCH within 5 business days from the execution of the Repurchase Agreement; (ii) a payment of RMB
50,000,000 ($7.54 million) of the Transfer Price to Xi’an TCH within 5 business days from the execution of the Repurchase
Agreement; and (iii) a payment of the remaining RMB 62,000,000 ($9.35 million) of the Transfer Price to Xi’an TCH within
15 business days from the execution of the Repurchase Agreement. Under the Repurchase Agreement, ownership of the project assets
will transfer from Xi’an TCH to Yida within 3 business days after Xi’an TCH receives the full Transfer Price and the
outstanding monthly leasing fees. As of June 30, 2016, Xi’an TCH had received the outstanding monthly leasing fees for April
and May 2016 of $0.90 million and the first payment of the Transfer Price of $7.54 million. On July 11, 2016, the Company received
the second payment of the Transfer Price of $9.35 million. The Company recorded a $0.42 million loss from this transaction.
The
Fund Management Company
On
June 25, 2013, Xi’an TCH and HongyuanHuifu Venture Capital Co. Ltd. (“HongyuanHuifu”) jointly established Hongyuan
Recycling Energy Investment Management Beijing Co., Ltd. (the “Fund Management Company”) with registered capital of
RMB 10 million ($1.45 million). Xi’an TCH made an initial capital contribution of RMB 4 million ($650,000) and has a 40%
ownership interest in the Fund Management Company. With respect to the Fund Management Company, voting rights and dividend rights
are allocated 80% and 20% between HongyuanHuifu and Xi’an TCH, respectively.
The Fund Management Company
is the general partner of Beijing Hongyuan Recycling Energy Investment Center, LLP (the “HYREF Fund”), a limited liability
partnership established on July 18, 2013 in Beijing. The Fund Management Company made an initial capital contribution of RMB 5
million ($830,000) to the HYREF Fund. An initial total amount of RMB 460 million ($75 million) was fully subscribed by all partners
for the HYREF Fund. The HYREF Fund has three limited partners: (1) China Orient Asset Management Co., Ltd., which made an initial
capital contribution of RMB 280 million ($46.67 million) to the HYREF Fund and is a preferred limited partner; (2) HongyuanHuifu,
which made an initial capital contribution of RMB 100 million ($16.67 million) to the HYREF Fund and is an ordinary limited partner;
and (3) the Company’s wholly-owned subsidiary, Xi’an TCH, which made an initial capital contribution of RMB 75 million
($12.5 million) to the HYREF Fund and is a secondary limited partner. The term of the HYREF Fund’s partnership is six years
from the date of its establishment, expiring July 18, 2019. The current term is four years from the date of contribution for the
preferred limited partner, and four years from the date of contribution for the ordinary limited partner. The total size of the
HYREF Fund is RMB 460 million ($76.66 million). The HYREF Fund was formed for the purpose of investing in Xi’an Zhonghong
New Energy Technology Co., Ltd., a 90% owned subsidiary of Xi’an TCH, for the construction of two coke dry quenching (“CDQ”)
WHPG stations with Jiangsu Tianyu Energy and Chemical Group Co., Ltd. (“Tianyu”) and one CDQ WHPG station with Boxing
County Chengli Gas Supply Co., Ltd. (“Chengli”).
Chengli
Waste Heat Power Generation Projects
On July 19, 2013, Xi’an
TCH formed a new company, “Xi’an Zhonghong New Energy Technology Co., Ltd.” (“Zhonghong”), with
registered capital of RMB 30 million ($4.85 million). Xi’an TCH paid RMB 27 million ($4.37 million) and owns 90% of Zhonghong.
Zhonghong is engaged to provide energy saving solution and services, including constructing, selling and leasing energy saving
systems and equipment to customers.
On July 24, 2013, Zhonghong
entered into a Cooperative Agreement of CDQ and CDQ WHPG Project with Boxing County Chengli Gas Supply Co., Ltd. (“Chengli”).
The parties entered into a supplement agreement on July 26, 2013. Pursuant to these agreements, Zhonghong will design, build and
maintain a 25 MW CDQ system and a CDQ WHPG system to supply power to Chengli, and Chengli will pay energy saving fees (the “Chengli
Project”). Chengli will contract the operation of the system to a third party contractor that is mutually agreed to by Zhonghong.
In addition, Chengli will provide the land for the CDQ system and CDQ WHPG system at no cost to Zhonghong. The term of the Agreements
is for 20 years. The first 800 million watt hours generated by the Chengli Project will be charged at RMB 0.42 ($0.068) per kilowatt
hour (excluding tax); thereafter, the energy saving fee will be RMB 0.20 ($0.036) per kilowatt hour (excluding tax). The operating
time shall be based upon an average 8,000 hours annually. If the operating time is less than 8,000 hours per year due to a reason
attributable to Chengli, then time charged shall be 8,000 hours a year, and if it is less than 8,000 hours due to a reason attributable
to Zhonghong, then it shall be charged at actual operating hours. The construction of the Chengli Project was completed in the
second quarter of 2015 and the project successfully completed commissioning tests in the first quarter of 2017. The Chengli Project
is now operational, but will not begin operations until the Company receives the required power generating license, which the
Company anticipates receiving in the third quarter of 2017. When operations begin, Chengli shall ensure its coking production
line works properly and that working hours for the CDQ system are at least 8,000 hours per year, and Zhonghong shall ensure that
working hours and the CDQ WHPG system will be at least 7,200 hours per year.
On July 22, 2013,
Zhonghong entered into an Engineering, Procurement and Construction (“EPC”) General Contractor Agreement for the Boxing
County Chengli Gas Supply Co., Ltd. CDQ Power Generation Project (the “Huaxin Project”) with Xi’an Huaxin New
Energy Co., Ltd. (“Huaxin”). Zhonghong, as the owner of the Huaxin Project, contracted EPC services for a CDQ system
and a 25 MW CDQ WHPG system for Chengli to Huaxin. Huaxin shall provide construction, equipment procurement, transportation, installation
and adjustment, test run, construction engineering management and other necessary services to complete the Huaxin Project and
ensure the CDQ system and CDQ WHPG system for Chengli meet the inspection and acceptance requirements and work normally. The Huaxin
Project is a turn-key project where Huaxin is responsible for monitoring the quality, safety, duration and cost of the Chengli
Project. The total contract price is RMB 200 million ($33.34 million), which includes all the materials, equipment, labor, transportation,
electricity, water, waste disposal, machinery and safety costs.
Tianyu
Waste Heat Power Generation Project
On
July 19, 2013, Zhonghong entered into a Cooperative Agreement (the “Tianyu Agreement”) for Energy Management of CDQ
and CDQ WHPG Project with Jiangsu Tianyu Energy and Chemical Group Co., Ltd. (“Tianyu”). Pursuant to the Tianyu Agreement,
Zhonghong will design, build, operate and maintain two sets of 25 MW CDQ systems and CDQ WHPG systems for two subsidiaries of
Tianyu – Xuzhou Tian’an Chemical Co., Ltd. (“Xuzhou Tian’an”) and Xuzhou Huayu Coking Co., Ltd (“Xuzhou
Huayu”) – to be located at Xuzhou Tian’an and Xuzhou Huayu’s respective locations (the “Tianyu Project”).
Upon completion of the Tianyu Project, Zhonghong will charge Tianyu an energy saving fee of RMB 0.534 ($0.087) per kilowatt hour
(excluding tax). The operating time will be based upon an average 8,000 hours annually for each of Xuzhou Tian’an and Xuzhou
Huayu. If the operating time is less than 8,000 hours per year due to a reason attributable to Tianyu, then time charged will
be 8,000 hours a year. The term of the Tianyu Agreement is 20 years. The construction of the Xuzhou Tian’an Project is anticipated
to be completed by the third quarter of 2017. Xuzhou Tian’an will provide the land for the CDQ and CDQ WHPG systems for
free. Xuzhou Tian’an also guarantees that it will purchase all of the power generated by the CDQ WHPG systems. The Xuzhou
Huayu Project is currently on hold due to a conflict between Xuzhou Huayu Coking Co., Ltd and local residents on certain pollution-related
issues. The local government has acted in its capacity to coordinate the resolution of this issue. The local residents were requested
to move from the hygienic buffer zone of the project location with compensatory payments from the government. Xuzhou Huayu was
required to stop production and implement technical innovations of pollution discharge including sewage treatment, dust collection,
noise control, and recycling of coal gas. Currently, some local residents have moved. Xuzhou Huayu has completed the implementation
of the technical innovations of sewage treatment, dust collection, and noice control, and expects to complete the recycling of
coal gas by the end of June 2017. Once Huayu obtains government’s acceptance and approval of the technical innovations,
the project will resume.
On
July 22, 2013, Zhonghong entered into an EPC General Contractor Agreement for the Tianyu Project with Xi’an Huaxin New Energy
Co., Ltd. (“Huaxin”). Zhonghong, as the owner of the Tianyu Project, contracted EPC services for two CDQ systems and
two 25 MW CDQ WHPG systems for Tianyu to Huaxin. Huaxin shall provide construction, equipment procurement, transportation, installation
and adjustment, test run, construction engineering management and other necessary services to complete the Tianyu Project and
ensure the CDQ and CDQ WHPG systems for Tianyu meet the inspection and acceptance requirements and work normally. The Tianyu Project
is a turn-key project where Huaxin is responsible for monitoring the quality, safety, duration and cost of the project. The total
contract price is RMB 400 million ($66.68 million), which includes all the materials, equipment, labor, transportation, electricity,
water, waste disposal, machinery and safety costs.
Zhongtai
Waste Heat Power Generation Energy Management Cooperative Agreement
On
December 6, 2013, Xi’an entered into a CDQ and WHPG Energy Management Cooperative Agreement (the “Zhongtai Agreement”)
with Xuzhou Zhongtai Energy Technology Co., Ltd. (“Zhongtai”), a limited liability company incorporated in Jiangsu
Province, China.
Pursuant
to the Zhongtai Agreement, Xi’an TCH will design, build and maintain a 150 ton per hour CDQ system and a 25 MW CDQ WHPG
system and sell the power to Zhongtai, and Xi’an TCH will also build a furnace to generate steam from the waste heat of
the smoke pipeline and sell the steam to Zhongtai.
The
construction period of the Project is expected to be 18 months from the date when conditions are ready for construction to begin.
Zhongtai will start to pay an energy saving service fee from the date when the WHPG station passes the required 72-hour test run.
The payment term is 20 years. For the first 10 years, Zhongtai shall pay an energy saving fee at RMB 0.534 ($0.089) per kilowatt
hour (including value added tax) for the power generated from the system. For the second 10 years, Zhongtai shall pay an energy
saving fee at RMB 0.402 ($0.067) per kilowatt hour (including value added tax). During the term of the contract the energy saving
fee shall be adjusted at the same percentage as the change of local grid electricity price. Zhongtai shall also pay an energy
saving fee for the steam supplied by Xi’an TCH at RMB 100 ($16.67) per ton (including value added tax). Zhongtai and its
parent company will provide guarantees to ensure Zhongtai will fulfill its obligations under the Agreement. Upon the completion
of the term, Xi’an TCH will transfer the systems to Zhongtai at RMB 1 ($0.16). Zhongtai shall provide waste heat to the
systems for no less than 8,000 hours per year and waste gas volume no less than 150,000 Nm3 per hour with a temperature no less
than 950°C. If these requirements are not met, the term of the Agreement will be extended accordingly. If Zhongtai wants to
terminate the Zhongtai Agreement early, it shall provide Xi’an TCH a 60 day notice and pay the termination fee and compensation
for the damages to Xi’an TCH according to the following formula: (1) if it is less than five years into the term when Zhongtai
requests termination, Zhongtai shall pay: Xi’an TCH’s total investment amount plus Xi’an TCH’s annual
investment return times five years minus the years in which the system has already operated); or 2) if it is more than five years
into the term when Zhongtai requests the termination, Zhongtai shall pay: Xi’an TCH’s total investment amount minus
total amortization cost (the amortization period is 10 years).
In
March 2016, Xi’an TCH entered into a Transfer Agreement of CDQ and a CDQ WHPG system with Zhongtai and Xi’an Huaxin
(the “Transfer Agreement”). Under the Transfer Agreement, Xi’an TCH agreed to transfer to Zhongtai all of the
assets associated with the CDQ Waste Heat Power Generation Project (the “Project”), which is under construction pursuant
to the Zhongtai Agreement. Xi’an Huaxin will continue to construct and complete the Project and Xi’an TCH agreed to
transfer all its rights and obligation under the “EPC” Contract to Zhongtai. As consideration for the transfer of
the Project, Zhongtai agreed to pay to Xi’an TCH an aggregate transfer price of RMB 167,360,000 ($25.77 million) including
payments of: (i) RMB 152,360,000 ($23.46 million) for the construction of the Project; and (ii) RMB 15,000,000 ($2.31 million)
as payment for partial loan interest accrued during the construction period. Those amounts have been, or will be, paid by Zhongtai
to Xi’an TCH according to the following schedule: (a) RMB 50,000,000 ($7.70 million) was paid within 20 business days after
the Transfer Agreement was signed; (b) RMB 30,000,000 ($4.32 million) will be paid within 20 business days after the Project is
completed, but no later than July 30, 2016; and (c) RMB 87,360,000 ($13.45 million) will be paid no later than July 30, 2017.
Xuzhou Taifa Special Steel Technology Co., Ltd. (“Xuzhou Taifa”) guaranteed the payments from Zhongtai to Xi’an
TCH. The ownership of the Project was conditionally transferred to Zhongtai following the initial payment of RMB 50,000,000 ($7.70
million) by Zhongtai to Xi’an TCH and the full ownership of the Project will be officially transferred to Zhongtai after
it completes all payments pursuant to the Transfer Agreement. As of March 31, 2017, Xi’an TCH had received the first payment
of $7.70 million and the second payment of $4.32 million. The Company recorded a $2.82 million loss from this transaction in 2016.
Rongfeng
CDQ Power Generation Energy Management Cooperative Agreement
On
December 12, 2013, Xi’an TCH entered into a CDQ Power Generation Energy Management Cooperative Agreement with Tangshan Rongfeng
Iron & Steel Co., Ltd. (the “Rongfeng Agreement”), a limited liability company incorporated in Hebei Province,
China.
Pursuant
to the Rongfeng Agreement, Xi’an TCH will design, build and maintain a CDQ and a CDQ WHPG system and sell the power to Rongfeng.
The construction period of the Project is expected to be 18 months after the Agreement takes effect and from the date when conditions
are ready for construction to begin.
Rongfeng
will start to pay an energy saving fee from the date when the WHPG station passes the required 72-hour test run. The payment term
is 20 years. For the first 10 years, Rongfeng shall pay an energy saving fee at RMB 0.582 ($0.095) per kilowatt hour (including
tax) for the power generated from the system. For the second 10 years, Rongfeng shall pay an energy saving fee at RMB 0.432 ($0.071)
per kWh (including tax). During the term of the contract the energy saving fee shall be adjusted at the same percentage as the
change of local grid electricity price. Rongfeng and its parent company will provide guarantees to ensure Rongfeng will fulfill
its obligations under the Rongfeng Agreement. Upon the completion of the term, Xi’an TCH will transfer the systems to Rongfeng
at RMB 1. Rongfeng shall provide waste heat to the systems for no less than 8,000 hours per year with a temperature no less than
950°C. If these requirements are not met, the term of the Agreement will be extended accordingly. If Rongfeng wants to terminate
the Agreement early, it shall provide Xi’an TCH a 60 day notice and pay the termination fee and compensation for the damages
to Xi’an TCH according to the following formula: 1) if it is less than five years (including five years) into the term when
Rongfeng requests termination, Rongfeng shall pay: Xi’an TCH’s total investment amount plus Xi’an TCH’s
average annual investment return times (five years minus the years of which the system has already operated); 2) if it is more
than five years into the term when Rongfeng requests the termination, Rongfeng shall pay: Xi’an TCH’s total investment
amount minus total amortization cost (the amortization period is 10 years). On November 16, 2015, Xi’an TCH entered into
a Transfer Agreement of CDQ and a CDQ WHPG system with Rongfeng and Xi’an Huaxin New Energy Co., Ltd., a limited liability
company incorporated in China (“Xi’an Huaxin”). The Transfer Agreement provided for the sale to Rongfeng of
the CDQ Waste Heat Power Generation Project (the “Project”) from Xi’an TCH. Additionally, Xi’an TCH would
transfer to Rongfeng the Engineering, Procurement and Construction (“EPC”) Contract for the CDQ Waste Heat Power Generation
Project which Xi’an TCH had entered into with Xi’an Huaxin in connection with the Project. As consideration for the
transfer of the Project, Rongfeng is to pay to Xi’an TCH an aggregate purchase price of RMB 165,200, 000 ($25.45 million),
whereby (a) RMB 65,200,000 ($10.05 million) was to be paid by Rongfeng to Xi’an TCH within 20 business days after signing
the Transfer Agreement, (b) RMB 50,000,000 ($7.70 million) is to be paid by Rongfeng to Xi’an TCH within 20 business days
after the Project is completed, but no later than March 31, 2016 and (c) RMB 50,000,000 ($7.70 million) will be paid by Rongfeng
to Xi’an TCH no later than September 30, 2016. Mr. Cheng Li, the largest stockholder of Rongfeng, has personally guaranteed
the payments. The ownership of the Project was conditionally transferred to Rongfeng within 3 business days following the initial
payment of RMB 65,200,000 ($10.05 million) by Rongfeng to Xi’an TCH and the full ownership of the Project will be officially
transferred to Rongfeng after it completes the entire payment pursuant to the Transfer Agreement. The Company recorded a $3.78
million loss from this transaction in 2015. As of December 31, 2016, the Company had received full payment of $25.45 million.
Formation
of Zhongxun
On
March 24, 2014, Xi’an TCH incorporated a new subsidiary, Zhongxun Energy Investment (Beijing) Co., Ltd (“Zhongxun”)
with registered capital of $5,695,502 (RMB 35,000,000). Zhongxun is 100% owned by Xi’an TCH and is mainly engaged in project
investment, investment management, economic information consulting, and technical services. Zhongxun has not yet commenced operations
as of the date of this report.
Formation
of Yinghua
On
February 11, 2015, the Company incorporated a new subsidiary, Shanghai Yinghua Financial Leasing Co., Ltd (“Yinghua”)
with registered capital of $30,000,000, to be paid within 10 years from the date the business license is issued. Yinghua is 100%
owned by the Company and is mainly engaged in financial leasing, purchase of financial leasing assets, disposal and repair of
financial leasing assets, consulting and ensuring of financial leasing transactions, and related factoring business. Yinghua has
not yet commenced operations as of the date of this report.
Summary
of Sales-Type Lease at March 31, 2017
Status
at March 31, 2017
As of March 31, 2017, Xi’an
TCH leases the following systems: (i) BMPG systems to Pucheng Phase I and II (15 and 11 year terms, respectively); (ii) BMPG systems
to Shenqiu Phase I (11-year term); and (iii) Shenqiu Phase II (9.5-year term). In addition, as of March 31, 2017, Erdos TCH leased
power and steam generating systems for recycling waste heat from metal refining to Erdos (five systems) for a term of 20 years.
Asset
Repurchase Agreement
During
the three months ended March 31, 2017 and the year ended December 31, 2016, the Company entered into the following Asset Repurchase
Agreements:
In
March 2016, Xi’an TCH entered into a Transfer Agreement of CDQ and a CDQ WHPG system with Zhongtai and Xi’an Huaxin
(the “Transfer Agreement”). Under the Transfer Agreement, Xi’an TCH agreed to transfer to Zhongtai all of the
assets associated with the CDQ Waste Heat Power Generation Project (the “Project”), which is under construction pursuant
to the Zhongtai Agreement. Xi’an Huaxin will continue to construct and complete the Project and Xi’an TCH agreed to
transfer all its rights and obligation under the “EPC” Contract to Zhongtai. As consideration for the transfer of
the Project, Zhongtai agreed to pay to Xi’an TCH an aggregate transfer price of RMB 167,360,000 ($25.77 million) including
payments of: (i) RMB 152,360,000 ($23.46 million) for the construction of the Project; and (ii) RMB 15,000,000 ($2.31 million)
as payment for partial loan interest accrued during the construction period. Those amounts have been, or will be, paid by Zhongtai
to Xi’an TCH according to the following schedule: (a) RMB 50,000,000 ($7.70 million) was paid within 20 business days after
the Transfer Agreement was signed; (b) RMB 30,000,000 ($4.32 million) will be paid within 20 business days after the Project is
completed, but no later than July 30, 2016; and (c) RMB 87,360,000 ($13.45 million) will be paid no later than July 30, 2017.
Xuzhou Taifa Special Steel Technology Co., Ltd. (“Xuzhou Taifa”) has guaranteed the payments from Zhongtai to Xi’an
TCH. The ownership of the Project was conditionally transferred to Zhongtai following the initial payment of RMB 50,000,000 ($7.70
million) by Zhongtai to Xi’an TCH and the full ownership of the Project will be officially transferred to Zhongtai after
it completes all payments pursuant to the Transfer Agreement. As of March 31, 2017, Xi’an TCH had received the first payment
of $7.70 million and the second payment of $4.32 million. The Company recorded a $2.82 million loss in 2016 from this transaction.
On June 22 2016, Xi’an
TCH entered into a Coal Oven Gas Power Generation Project Repurchase Agreement (the “Repurchase Agreement”) with Yida.
Under the Repurchase Agreement, Xi’an TCH agreed to transfer to Yida all the project assets for RMB 112,000,000 ($16.89
million) (the “Transfer Price”) with Yida’s retention of ownership of the Shares. Yida agreed to make the following
payments: (i) the outstanding monthly leasing fees for April and May 2016 in total of RMB 6,000,000 ($0.90 million) to Xi’an
TCH within 5 business days from the execution of the Repurchase Agreement; (ii) a payment of RMB 50,000,000 ($7.54 million) of
the Transfer Price to Xi’an TCH within 5 business days from the execution of the Repurchase Agreement; and (iii) a payment
of the remaining RMB 62,000,000 ($9.35 million) of the Transfer Price to Xi’an TCH within 15 business days from the execution
of the Repurchase Agreement. Under the Repurchase Agreement, ownership of the project assets will be transferred from Xi’an
TCH to Yida within 3 business days after Xi’an TCH receives the full Transfer Price and the outstanding monthly leasing
fees. As of March 31, 2017, Xi’an TCH had received the outstanding monthly leasing fees for April and May 2016 of $0.90
million. As of December 31, 2016, the Company had received the first payment of the Transfer Price in the amount of $7.54 million,
and the second payment of the Transfer Price of $9.35 million. The Company recorded a $0.42 million loss in 2016 from this transaction.
Reverse
Stock Split
On
May 24, 2016, the Company filed a Certificate of Change with the Secretary of State of Nevada with an effective date of May 25,
2016 (the “Effective Date”), at which time the Company effected a 1-for-10 reverse stock split of the Company’s
authorized shares of common stock, par value $0.001 (the “Common Stock”), accompanied by a corresponding decrease
in the Company’s issued and outstanding shares of Common Stock (the “Reverse Stock Split”).
The
Company rounded up to the next full share of the Company’s Common Stock any fractional shares resulting from the Reverse
Stock Split. The Reverse Stock Split was retroactively stated for the periods covered by the financial statements included herein.
2.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis
of Presentation
The
unaudited financial statements included herein were prepared by the Company, pursuant to the rules and regulations of
the Securities and Exchange Commission (“SEC”). The information furnished herein reflects all adjustments (consisting
of normal recurring accruals and adjustments) that are, in the opinion of management, necessary to fairly present the operating
results for the respective periods. Certain information and footnote disclosures normally present in annual financial statements
prepared in accordance with accounting principles generally accepted in the United States of America (“US GAAP”) were
omitted pursuant to such rules and regulations. These financial statements should be read in conjunction with the audited financial
statements and footnotes included in the Company’s 2016 audited financial statements included in the Company’s
Annual Report on Form 10-K. The results for the three months ended March 31, 2017 are not necessarily indicative of the results
expected for the full year ending December 31, 2017.
Basis
of Consolidation
The
consolidated financial statements (“CFS”) include the accounts of CREG and its subsidiaries, Shanghai Yinghua Financial
Leasing Co., Ltd. (“Yinghua”) and Sifang Holdings, its wholly owned subsidiaries, Huahong New Energy Technology Co.,
Ltd. (“Huahong”) and Shanghai TCH, Shanghai TCH’s wholly-owned subsidiary, Xi’an TCH Energy Tech Co.,
Ltd. (“Xi’an TCH”) and Xi’an TCH’s subsidiaries, Erdos TCH Energy Saving Development Co., Ltd (“Erdos
TCH”), 100% owned by Xi’an TCH (See note 1), Zhonghong, 90% owned by Xi’an TCH, and Zhongxun, 100% owned by
Xi’an TCH. Substantially all of the Company’s revenues are derived from the operations of Shanghai TCH and its subsidiaries,
which represent substantially all of the Company’s consolidated assets and liabilities as of March 31, 2017 and December
31, 2016, respectively. All significant inter-company accounts and transactions were eliminated in consolidation.
Use
of Estimates
In
preparing these CFS in accordance with US GAAP, management makes estimates and assumptions that affect the reported amounts of
assets and liabilities in the balance sheets as well as revenues and expenses during the period reported. Actual results may differ
from these estimates.
Revenue
Recognition
Sales-type
Leasing and Related Revenue Recognition
The
Company constructs and leases waste energy recycling power generating projects to its customers. The Company typically transfers
ownership of the waste energy recycling power generating projects to its customers at the end of the lease. The investment in
these projects is recorded as investment in sales-type leases in accordance with Financial Accounting Standards Board (“FASB”)
Accounting Standards Codification (“ASC”) Topic 840
, “Lease
s
,”
and its various amendments
and interpretations. The Company finances construction of waste energy recycling power generating projects. The sales and cost
of sales are recognized at the inception of the lease. The investment in sales-type leases consists of the sum of the minimum
lease payments receivable less unearned interest income and estimated executory cost. Minimum lease payments are part of the lease
agreement between the Company (as the lessor) and the customer (as the lessee). The discount rate implicit in the lease is used
to calculate the present value of minimum lease payments. The minimum lease payments consist of the gross lease payments net of
executory costs and contingent rentals, if any. Unearned interest income is amortized to income over the lease term to produce
a constant periodic rate of return on net investment in the lease. While revenue is recognized at the inception of the lease,
the cash flow from the sales-type lease occurs over the course of the lease, which results in interest income and reduction of
receivables. Revenue is recognized net of sales tax.
Contingent
Rental Income
The
Company records income from actual electricity usage in addition to minimum lease payments of each project as contingent rental
income in the period contingent rental income is earned. Contingent rent is not part of minimum lease payments.
Cash
and Equivalents
Cash
and equivalents includes cash on hand, demand deposits placed with banks or other financial institutions and all highly liquid
investments with an original maturity of three months or less as of the purchase date of such investments.
Accounts
Receivable
As
of March 31, 2017, the Company had accounts receivable of $12,662,154 (from sale of CDQ and a CDQ WHPG system to Zhongtai). As
of December 31, 2016, the Company had accounts receivable of $12,593,340 (from sale of CDQ and a CDQ WHPG system to Zhongtai),
respectively.
Interest
Receivable on Sales Type Leases
As
of March 31, 2017, the interest receivable on sales type leases was $6,450,202, mainly from recognized but not yet collected interest
income for the Pucheng and Shenqiu systems. As of December 31, 2016, the interest receivable on sales type leases was $4,621,491.
The
Company maintains reserves for potential credit losses on receivables. Management reviews the composition of receivables and analyzes
historical bad debts, customer concentrations, customer credit worthiness, current economic trends and changes in customer payment
patterns to evaluate the adequacy of these reserves.
Property
and Equipment
Property
and equipment are stated at cost, net of accumulated depreciation. Expenditures for maintenance and repairs are expensed as incurred;
additions, renewals and betterments are capitalized. When property and equipment are retired or otherwise disposed of, the related
cost and accumulated depreciation are removed from the respective accounts, and any gain or loss is included in operations. Depreciation
of property and equipment is provided using the straight-line method over the estimated lives as follows:
Building
|
|
|
20
years
|
|
Vehicles
|
|
|
2
- 5 years
|
|
Office and Other Equipment
|
|
|
2
- 5 years
|
|
Software
|
|
|
2
- 3 years
|
|
Impairment
of Long-lived Assets
In
accordance with FASB ASC Topic 360,
“Property, Plant, and Equipment
,” the Company reviews its long-lived
assets, including property and equipment, for impairment whenever events or changes in circumstances indicate that the carrying
amounts of the assets may not be fully recoverable. If the total expected undiscounted future net cash flows is less than the
carrying amount of the asset, a loss is recognized for the difference between the fair value and carrying amount of the asset.
The total undiscounted future net cash flow (total future payment receivable) is less than net investment in sales-type leases
for Erdos Phase II, the 2nd
system at December 31, 2016; accordingly, the Company recorded
an asset impairment loss of $242,305 for the year ended December 31, 2016. There was no impairment as of March 31, 2017.
Notes
Payable – Banker’s Acceptances
The
Company endorses banker’s acceptances that are issued from a bank to vendors as payment for its obligations. Most of the
banker’s acceptances have maturity dates of less than six months following their issuance.
Cost
of Sales
Cost
of sales consists primarily of the direct material of the power generating system and expenses incurred directly for project construction
for sales-type leasing and sales tax and additions for contingent rental income.
Noncontrolling
Interests
The
Company follows FASB ASC Topic 810,
“Consolidation,”
which established new standards governing the
accounting for and reporting of noncontrolling interests (“NCIs”) in partially owned consolidated subsidiaries and
the loss of control of subsidiaries. Certain provisions of this standard indicate, among other things, that NCIs (previously referred
to as minority interests) be treated as a separate component of equity, not as a liability (as was previously the case), that
increases and decreases in the parent’s ownership interest that leave control intact be treated as equity transactions rather
than as step acquisitions or dilution gains or losses, and that losses of a partially-owned consolidated subsidiary be allocated
to NCIs even when such allocation might result in a deficit balance.
The
net income (loss) attributed to NCIs was separately designated in the accompanying statements of income and comprehensive income
(loss). Losses attributable to NCIs in a subsidiary may exceed an NCI’s interests in the subsidiary’s equity. The
excess attributable to NCIs is attributed to those interests. NCIs shall continue to be attributed their share of losses even
if that attribution results in a deficit NCI balance.
Fair
Value of Financial Instruments
For
certain of the Company’s financial instruments, including cash and equivalents, restricted cash, accounts receivable, other
receivables, accounts payable, accrued liabilities and short-term debts, the carrying amounts approximate their fair values due
to their short maturities. Receivables on sales-type leases are based on interest rates implicit in the lease.
FASB
ASC Topic 820,
“Fair Value Measurements and Disclosures,”
requires disclosure of the fair value (“FV”)
of financial instruments held by the Company. FASB ASC Topic 825,
“Financial Instruments,”
defines
FV, and establishes a three-level valuation hierarchy for disclosures of FV measurement that enhances disclosure requirements
for FV measures. The carrying amounts reported in the consolidated balance sheets for receivables and current liabilities each
qualify as financial instruments and are a reasonable estimate of their FV because of the short period of time between the origination
of such instruments and their expected realization and their current market rate of interest. The three levels of valuation hierarchy
are defined as follows:
|
●
|
Level
1 inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.
|
|
|
|
|
●
|
Level
2 inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs
that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial
instrument.
|
|
|
|
|
●
|
Level
3 inputs to the valuation methodology are unobservable and significant to FV measurement.
|
The
Company analyzes all financial instruments with features of both liabilities and equity under ASC 480,
“Distinguishing
Liabilities from Equity,”
and ASC 815,
“Derivatives and Hedging.”
The
following are the considerations with respect to disclosures of FV of long-term debt obligations:
As
of March 31, 2017, the Company’s long-term debt obligations consisted of the Zhonghong entrusted loan of $48.12 million
(Note 12). As of December 31, 2016, the Company’s long-term debt obligations consisted of the Zhonghong entrusted loan of
$47.86 million.
FV
measurements and approximations for certain financial instruments are based on what a reporting entity would likely have to pay
to transfer the financial obligation to an entity with a comparable credit rating. The Company’s bank loans and trust loans
payable are privately held (i.e., nonpublic) debt; therefore, pricing inputs are not observable. For this reason, the Company
classified bank loans and trust loans payable as a Level 3 FV measurement in the valuation hierarchy.
For
the Company’s long-term bank loans, ZRIT trust loan and Zhonghong entrusted loans noted above, the Company believes the
carrying amounts approximate their FV. Based on the Company’s understanding of the credit markets, the Company’s business
is in a sector (energy-saving green) that is supported by the PRC government and the lending bank, the Company believes it could
have obtained similar loans on similar terms and interest rates. In addition, in connection with the FV measurement, the Company
considered nonperformance risk (including credit risk) relating to the debt obligations, including the following: (i) the Company
is considered a low credit risk customer to the lending bank and its creditors; (ii) the Company has a good history of making
timely payments and have never defaulted on any loans; and (iii) the Company has a stable and continuous cash inflow from collections
from its sales-type lease of energy saving projects.
As
of March 31, 2017 and December 31, 2016, the Company did not identify any assets or liabilities that are required to be presented
on the balance sheet at FV.
Stock-Based
Compensation
The
Company accounts for its stock-based compensation in accordance with FASB ASC Topic 718
“Compensation—Stock
Compensation,”
and FASB ASC Topic 505, “
Equity.”
The Company recognizes in its statement
of operations FV at the grant date for stock options and other equity-based compensation issued to employees and non-employees.
Basic
and Diluted Earnings per Share
The
Company presents net income (loss) per share (“EPS”) in accordance with FASB ASC Topic 260,
“Earning
Per Share.”
Accordingly, basic income (loss) per share is computed by dividing income (loss) available to common
stockholders by the weighted average number of shares outstanding, without consideration for common stock equivalents. Diluted
EPS is computed by dividing the net income by the weighted-average number of common shares outstanding as well as common share
equivalents outstanding for the period determined using the treasury-stock method for stock options and warrants and the if-converted
method for convertible notes. The Company made an accounting policy election to use the if-converted method for convertible securities
that are eligible to receive common stock dividends, if declared. Diluted EPS reflect the potential dilution that could occur
based on the exercise of stock options or warrants or conversion of convertible securities using the if-converted method.
The
following table presents a reconciliation of basic and diluted EPS for the three months ended March 31, 2017 and 2016:
|
|
2017
|
|
|
2016
|
|
Net income
|
|
$
|
374,421
|
|
|
$
|
93,026
|
|
|
|
|
|
|
|
|
|
|
Weighted average shares outstanding – basic
|
|
|
8,310,198
|
|
|
|
83,084,035
|
|
Effect of dilutive securities:
|
|
|
|
|
|
|
|
|
Options granted
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
Weighted average shares outstanding – diluted
|
|
|
8,310,198
|
|
|
|
83,084,035
|
|
Earnings per share – basic
|
|
$
|
0.05
|
|
|
$
|
0.00
|
|
Earnings per share – diluted
|
|
$
|
0.05
|
|
|
$
|
0.00
|
|
Foreign
Currency Translation and Comprehensive Income (Loss)
The
Company’s functional currency is the Renminbi (“RMB”). For financial reporting purposes, RMB were translated
into United States Dollars (“USD” or “$”) as the reporting currency. Assets and liabilities are translated
at the exchange rate in effect at the balance sheet date. Revenues and expenses are translated at the average rate of exchange
prevailing during the reporting period. Translation adjustments arising from the use of different exchange rates from period to
period are included as a component of stockholders’ equity as “Accumulated other comprehensive income.” Gains
and losses resulting from foreign currency transactions are included in income. There was no significant fluctuation in the exchange
rate for the conversion of RMB to USD after the balance sheet date.
The
Company follows FASB ASC Topic 220,
“Comprehensive Income.”
Comprehensive income is comprised of
net income and all changes to the statements of stockholders’ equity, except those due to investments by stockholders, changes
in paid-in capital and distributions to stockholders.
Segment
Reporting
FASB
ASC Topic 280,
“Segment Reporting,”
requires use of the “management approach” model for
segment reporting. The management approach model is based on the way a company’s management organizes segments within the
company for making operating decisions and assessing performance. Reportable segments are based on products and services, geography,
legal structure, management structure, or any other manner in which management disaggregates a company. FASB ASC Topic 280 has
no effect on the Company’s financial statements as substantially all of the Company’s operations are conducted in
one industry segment. All of the Company’s assets are located in the PRC.
New
Accounting Pronouncements
In
February 2016, the FASB issued Accounting Standards Update (“ASU”) No. 2016-02, Leases (Topic 842). The guidance in
ASU 2016-02 supersedes the lease recognition requirements in ASC Topic 840, Leases (FAS 13). ASU 2016-02 requires an entity to
recognize assets and liabilities arising from a lease for both financing and operating leases, along with additional qualitative
and quantitative disclosures. ASU 2016-02 is effective for fiscal years beginning after December 15, 2018, with early adoption
permitted. The Company is currently evaluating the effect this standard will have on its CFS.
On
March 30, 2016, the FASB issued ASU No. 2016-09, Improvements to Employee Share-Based Payment Accounting, which includes amendments
to accounting for income taxes at settlement, forfeitures, and net settlements to cover withholding taxes. The amendments in ASU
2016-09 are effective for public companies for fiscal years beginning after December 31, 2016, and interim periods within those
annual periods. Early adoption is permitted but requires all elements of the amendments to be adopted at once rather than individually.
The Company is evaluating the effect that ASU No. 2016-09 will have on the Company’s CFS.
In
August 2016, the FASB issued ASU No. 2016-15, Classification of Certain Cash Receipts and Cash Payments. ASU 2016-15 clarifies
the presentation and classification of certain cash receipts and cash payments in the statement of cash flows. This ASU is effective
for public business entities for fiscal years, and interim periods within those years, beginning after December 15, 2017. Early
adoption is permitted. The Company is currently assessing the potential impact of ASU 2016-15 on its CFS.
In
October 2016, the FASB issued ASU No. 2016-16—Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory.
This ASU improves the accounting for the income tax consequences of intra-entity transfers of assets other than inventory. For
public business entities, the amendments in this update are effective for annual reporting periods beginning after December 15,
2017, including interim reporting periods within those annual reporting periods. Early adoption is permitted. The Company does
not anticipate that the adoption of this ASU will have a significant impact on its CFS.
Other
recent accounting pronouncements issued by the FASB, including its Emerging Issues Task Force, the American Institute of Certified
Public Accountants, and the SEC did not or are not believed by management to have a material impact on the Company’s present
or future CFS.
Reclassification
In
November 2015, the FASB issued an ASU on the balance sheet classification of deferred taxes, which would require that deferred
tax assets and liabilities be classified as non-current in the balance sheet. Current GAAP requires the presentation of deferred
tax assets and liabilities as either current or non-current in the balance sheet. This ASU is effective for annual reporting periods
beginning after December 15, 2016, including interim reporting periods within those annual reporting periods. Earlier adoption
is permitted. The guidance may be applied either prospectively or retrospectively. The Company adopted this ASU as of December
31, 2016 on a retrospective basis and reclassified current deferred tax liability (net) to the noncurrent deferred tax liability
(net) in the consolidated balance sheet for the year ended December 31, 2016. The reclassification had no effect on reported revenues,
operating income, or cash flows for the periods presented.
3.
RESTRICTED CASH
Restricted
cash is held by the banks as collateral to issue bank acceptances and bank loans. The Company endorses bank acceptances to vendors
as payment of its obligations. Most of the bank acceptances have maturities of less than six months. As of March 31, 2017 and
December 31, 2016, the Company had restricted cash of $0.
4.
INVESTMENT IN SALES-TYPE LEASES, NET
Under
sales-type leases, Xi’an TCH leases the following systems: (i) BMPG systems to Pucheng Phase I and II (15 and 11 year terms,
respectively); (ii) BMPG systems to Shenqiu Phase I (11-year term); and (iii) Shenqiu Phase II (9.5-year term). In addition, as
of March 31, 2017, Erdos TCH leased power and steam generating systems from waste heat from metal refining to Erdos (five systems)
for a term of twenty years. The components of the net investment in sales-type leases as of March 31, 2017 and December 31, 2016
are as follows:
|
|
2017
|
|
|
2016
|
|
Total future minimum lease payments receivable
|
|
$
|
218,176,104
|
|
|
$
|
217,470,913
|
|
Less: executory cost
|
|
|
(66,443,813
|
)
|
|
|
(66,444,519
|
)
|
Less: unearned interest income
|
|
|
(33,638,086
|
)
|
|
|
(35,312,473
|
)
|
Less: realized interest income but not yet received
|
|
|
(6,450,202
|
)
|
|
|
(4,621,490
|
)
|
Investment in sales-type leases, net
|
|
|
111,644,003
|
|
|
|
111,092,431
|
|
Current portion
|
|
|
11,034,452
|
|
|
|
9,385,453
|
|
Noncurrent portion
|
|
$
|
100,609,551
|
|
|
$
|
101,706,978
|
|
As
of March 31, 2017, the future minimum rentals to be received on non-cancelable sales-type leases by years are as follows:
2018
|
|
$
|
31,176,332
|
|
2019
|
|
|
19,038,721
|
|
2020
|
|
|
19,038,721
|
|
2021
|
|
|
20,600,876
|
|
2022
|
|
|
20,671,489
|
|
Thereafter
|
|
|
107,649,965
|
|
Total
|
|
$
|
218,176,104
|
|
5.
PREPAID EXPENSES
Prepaid
expenses mainly consisted of prepayment for office rental and decorations, taxes, and consulting fees for the Company’s
HYREF fund completed in July 2013. Before the HYREF Fund released the money to Zhonghong, Xi’an TCH paid 2% of the funds
raised for Zhonghong, i.e. RMB 9.2 million ($1.5 million) to the Fund Management Company as a consulting fee and it shall pay
such 2% on the amount of funds actually contributed as an annual management fee on every 365-day anniversary thereafter until
Zhonghong fully repays the loan, and the HYREF Fund no longer has an ownership interest in Zhonghong. The Company had $0.37 million
and $0.65 million prepaid consulting expense as of March 31, 2017 and December 31, 2016, respectively. The Company had $17,263
and $32,050 prepaid tax as of March 31, 2017 and December 31, 2016.
6.
OTHER RECEIVABLES
As of March 31, 2017, other
receivables mainly consisted of (i) advances to third parties of $0.01 million, bearing no interest, payable upon demand,(ii)
maintenance cost and tax receivable of $1.63 million; and (iii) advances to employees of $0.02 million, bearing no interest, payable
upon demand. As of December 31, 2016, other receivables mainly consisted of advance to third party of $0.53 million, bearing no
interest, payable upon demand; and advance to employees of $0.02 million, bearing no interest, payable upon demand.
7.
LONG TERM INVESTMENT
On
June 25, 2013, Xi’an TCH with HongyuanHuifu Venture Capital Co. Ltd (“HongyuanHuifu”) jointly established Hongyuan
Recycling Energy Investment Management Beijing Co., Ltd (the “Fund Management Company”) with registered capital of
RMB 10 million ($1.6 million), to manage a fund that will be used for financing CDQ WHPG projects. Xi’an TCH made an initial
capital contribution of RMB 4 million ($0.65 million) and has a 40% ownership interest in the Fund Management Company. Voting
rights and dividend rights are allocated between HongyuanHuifu and Xi’an TCH at 80% and 20%, respectively. The Company accounted
for this investment using the equity method. The Company recorded $39,751 equity based investment income during the three months
ended March 31, 2017; however, it was eliminated with the financial fee of Zhonghong for the Statement of Income as 100% of Fund
Management Company’s revenue is from Zhonghong’s financial fee and Zhonghong is 91.7% owned by Xi’an TCH (see
Note 12). Xi’an TCH paid a $1.6 million one-time commission (recorded as other expense) to the Fund Management Company during
2013 for initiating and completing the Fund financing for the Company.
On July 18, 2013, the HYREF
Fund was established as a limited liability partnership in Beijing. Pursuant to the Partnership Agreement, the HYREF Fund has
a general partner, the Fund Management Company, which made an initial capital contribution of RMB 5 million ($0.83 million) to
the HYREF Fund. The HYREF Fund has three limited partners: (1) China Orient Asset Management Co., Ltd., which made an initial
capital contribution of RMB 280 million ($46.67 million) and is a preferred limited partner, (2) HongyuanHuifu, which made an
initial capital contribution of RMB 100 million ($16.67 million) and is an ordinary limited partner and (3) the Company’s
wholly-owned subsidiary, Xian TCH, which made an initial capital contribution of RMB 75 million ($10.81 million) and is a secondary
limited partner. The term of the HYREF Fund’s partnership is six years from the date of its establishment, July 18, 2013.
The current term for the preferred limited partner is four years from the date of its contribution and for the ordinary limited
partner is four years from the date of its contribution. Unless otherwise approved by the general partner (the Fund Management
Company), upon the expiration of their respective terms, each partner shall exit from the partnership automatically. The total
size of the HYREF Fund is RMB 460 million ($75.0 million), and the purpose of the HYREF Fund is to invest in Zhonghong for constructing
3 new CDQ WHPG projects. Xi’an TCH owns 16.3% of the HYREF Fund. The Company accounted for this investment using the cost
method. The Company netted off the investment of RMB 75 million ($10.81 million) by Xi’an TCH with the entrusted loan payable
of the HYREF Fund.
8.
CONSTRUCTION IN PROGRESS
Construction
in progress was for constructing power generation systems. As of March 31, 2017 and December 31, 2016, the Company’s construction
in progress included:
|
|
March 31,
2017
|
|
|
December 31,
2016
|
|
Xuzhou Huayu
|
|
$
|
23,654,478
|
|
|
$
|
23,525,925
|
|
Xuzhou Tian’an
|
|
|
33,429,612
|
|
|
|
32,471,977
|
|
Boxing County Chengli
|
|
|
30,661,916
|
|
|
|
30,495,280
|
|
Total
|
|
$
|
87,746,006
|
|
|
$
|
86,493,182
|
|
As
of March 31, 2017, the Company was committed to pay an additional (1) $11.60 million for Xuzhou Huayu project, (2) $4.02 million
for Xuzhou Tian’an project, and (3) $4.47 million for Boxing County Chengli project.
9.
TAXES PAYABLE
Taxes
payable consisted of the following as of March 31, 2017 and December 31, 2016:
|
|
2017
|
|
|
2016
|
|
Income
|
|
$
|
884,831
|
|
|
$
|
773,397
|
|
VAT
|
|
|
578,041
|
|
|
|
366,230
|
|
Other
|
|
|
92,783
|
|
|
|
63,050
|
|
Total
|
|
$
|
1,555,655
|
|
|
$
|
1,202,677
|
|
10.
ACCRUED LIABILITIES AND OTHER PAYABLES
Accrued
liabilities and other payables consisted of the following as of March 31, 2017 and December 31, 2016:
|
|
2017
|
|
|
2016
|
|
Employee training, labor union expenditure and social insurance payable
|
|
$
|
764,174
|
|
|
$
|
760,021
|
|
Consulting, auditing, and legal expenses
|
|
|
212,126
|
|
|
|
468,393
|
|
Accrued payroll and welfare
|
|
|
299,545
|
|
|
|
322,605
|
|
Accrued interest
|
|
|
1,262
|
|
|
|
1,569
|
|
Other
|
|
|
67,191
|
|
|
|
43,992
|
|
Total
|
|
$
|
1,344,298
|
|
|
$
|
1,596,580
|
|
11.
DEFERRED TAX LIABILITY, NET
Deferred
tax asset resulted from accrued employee social insurance that can be deducted for tax purposes in the future, and the difference
between tax and accounting basis of cost of fixed assets which was capitalized for tax purposes and expensed as part of cost of
systems in accordance with US GAAP. Deferred tax liability arose from the difference between tax and accounting basis of net investment
in sales-type leases.
As
of March 31, 2017 and December 31, 2016, deferred tax liability consisted of the following:
|
|
2017
|
|
|
2016
|
|
Deferred tax asset — current (accrual of employee social insurance)
|
|
$
|
168,898
|
|
|
$
|
167,980
|
|
Deferred tax liability — current (net investment in sales-type
leases)
|
|
|
(1,653,909
|
)
|
|
|
(1,586,058
|
)
|
Deferred tax liability, net of current deferred tax asset
|
|
|
(1,485,011
|
)
|
|
|
(1,418,078
|
)
|
|
|
|
|
|
|
|
|
|
Deferred tax asset — noncurrent (depreciation of fixed assets)
|
|
|
17,610,849
|
|
|
|
17,943,843
|
|
Deferred tax liability — noncurrent (net investment in sales-type
leases)
|
|
|
(25,152,388
|
)
|
|
|
(25,426,744
|
)
|
Deferred tax liability, net of noncurrent deferred tax asset
|
|
|
(7,541,539
|
)
|
|
|
(7,482,901
|
)
|
|
|
|
|
|
|
|
|
|
Total Deferred tax liability, noncurrent
|
|
$
|
9,026,550
|
|
|
$
|
8,900,979
|
|
12.
LOANS PAYABLE
Entrusted
Loan Payable
The HYREF Fund (Beijing Hongyuan
Recycling Energy Investment Center, LLP) established in July 2013 with total fund size of RMB 460 million ($75.0 million) invests
in Xi’an Zhonghong for Zhonghong’s three new CDQ WHPG projects. The HYREF Fund invested RMB 3 million ($0.5 million)
as an equity investment and RMB 457 million ($74.5 million) as a debt investment in Xi’an Zhonghong; in return for such
investments, the HYREF Fund will receive interest from Zhonghong for the HYREF Fund’s debt investment. The RMB 457 million
($74.5 million) was released to Zhonghong through an entrusted bank, which is also the supervising bank for the use of the loan.
The loan was deposited in a bank account at the Supervising Bank (the Industrial Bank Xi’an Branch) and is jointly supervised
by Zhonghong and the Fund Management Company. Project spending shall be verified by the Fund Management Company to confirm that
it is in accordance with the project schedule before the funds are released. All the operating accounts of Zhonghong have been
opened with the branches of the Supervising Bank and the Supervising Bank has the right to monitor all bank accounts opened by
Zhonghong. The entrusted bank will charge 0.1% of loan amount as service fee and will not take any lending risk. The loan was
collateralized by the accounts receivable and the fixed assets of Shenqiu Phase I and II power generation systems, the accounts
receivable and fixed assets of Zhonghong’s three CDQ WHPG systems, and a 27 million RMB capital contribution made by Xi’an
TCH. Repayment of the loan (principal and interest) was also jointly and severally guaranteed by Xi’an TCH and the Chairman
and CEO of the Company. In the fourth quarter of 2015, three power stations of Erdos TCH were pledged to Industrial Bank as an
additional guarantee for the loan lent to Zhonghong’s three CDQ WHPG systems. In 2016, two additional power stations of
Erdos TCH and Pucheng Phase I and II systems were pledged to Industrial Bank as an additional guarantee along with Xi’an
TCH’s equity in Zhonghong.
The
loan agreement provides that Zhonghong shall also maintain a certain capital level in its account with the Supervising Bank to
make sure it has sufficient funds to make interest payments when they are due:
|
●
|
During
the first three years from the first release of the loan, the balance in its account shall be no less than RMB 7.14 million
($1.19 million) on the 20th day of the second month of each quarter and no less than RMB 14.28 million ($2.38 million) on
the 14th day of the last month of each quarter;
|
|
●
|
During
the fourth year from the first release of the loan, the balance in its account shall be no less than RMB 1.92 million ($0.32
million) on the 20th day of the second month of each quarter and no less than RMB 3.85 million ($0.64 million) on the 14th
day of the last month of each quarter; and
|
|
|
|
|
●
|
During
the fifth year from the first release of the loan, the balance in its account shall be no less than RMB 96,300 ($16,050) on
the 20th day of the second month of each quarter and no less than RMB 192,500 ($32,080) on the 14th day of the last month
of each quarter.
|
The term of this loan is for
60 months from July 31, 2013 to July 30, 2018. On August 6, 2016, Zhonghong shall repay principal of RMB 280 million ($42.22 million);
on August 6, 2017, Zhonghong shall repay principal of RMB 100 million ($16.27 million) and on July 30, 2018, Zhonghong shall repay
the remainder of RMB 77 million ($12.52 million). The interest rate is 12.5%. During the term, Zhonghong shall maintain a minimal
funding level and capital level in its designated account with the Supervising Bank to make sure it has sufficient funds to make
principal payments when they are due. Notwithstanding the requirement, there is a verbal agreement from the HYREF Fund that for
the purpose of the efficient utilization of working capital, Zhonghong does not have to maintain a minimum funding level in its
designated account with the Supervising Bank. As of March 31, 2017, the entrusted loan payable had an outstanding balance of $58.99
million, of which, $10.87 million was from the investment of Xi’an TCH; accordingly, the Company netted the loan payable
of $10.87 million with the long-term investment to the HYREF Fund made by Xi’an TCH. For the three months ended March 31,
2017, the Company recorded interest expense of $1.07 million on this loan and capitalized $0.78 million interest to construction
in progress. For the three months ended March 31, 2016, the Company recorded interest expense of $0.82 million on this loan and
capitalized $1.39 million interest to construction in progress. As of the date of this report, the Company had fully paid RMB
50 million ($7.54 million) of the RMB 280 million ($42.22 million), and on August 5, 2016, the Company entered a supplemental
agreement with the lender to extend the due date of the remaining RMB 230 million ($34.68 million) of the original RMB 280 million
($45.54 million) to August 6, 2017.
Due to the slow progress of
the construction of the three CDQ WHPG projects, the Company has applied for a lower interest rate from the lender since January
of 2017, and is currently waiting for the lender’s decision. The Company has temporarily stopped making interest payments
during the waiting period. As of March 31, 2017, the interest payable for this loan was $2.07 million.
Bank
Loan – Bank of Xi’an
On
June 26, 2015, Xi’an TCH entered into a loan agreement with Bank of Xi’an, whereby Bank of Xi’an loaned $6.29
million (RMB 40 million) to Xi’an TCH for one year due on June 25, 2016. The monthly interest on the loan was 0.595%. Under
the terms of the loan, Xi’an TCH was required to make monthly interest payments and the principal was to be repaid at maturity.
The loan was guaranteed by a third party guarantee company and the Chairman and CEO of the Company. The Company paid a third party
$149,341 (RMB 950,000) as a re-guarantee service fee. As of December 31, 2016, this loan was paid in full.
Bank
Loan – Bank of Chongqing
On
April 11, 2014, Xi’an TCH entered into a loan agreement with Bank of Chongqing - Xi’an Branch, whereby Bank of Chongqing
loaned $8.13 million (RMB 50 million) to Xi’an TCH for three years with maturity on April 10, 2017. The interest of the
loan is 9.225%. Under the terms of the loan, Xi’an TCH was required to make monthly interest payments and, to make a principal
payment of $0.81 million (RMB 5 million) on the 24
th
month after receiving the loan and of the remaining $7.32
million (RMB 45 million) on the loan maturity date. The loan was guaranteed by a third party guarantee company and the Chairman
and CEO of the Company. The Company paid a third party $155,280 (RMB 950,000) as a re-guarantee service fee. In addition, Xi’an
TCH pledged its collection right for Tangshan Rongfeng and Xuzhou Zhongtai projects to Bank of Chongqing after the two projects
were completed and put into operation, to ensure the repayment of loan. As of March 31, 2017, this loan had an outstanding balance
of $0.58 million and was classified as a current liability.
Trust
Loan - Zhongrong International Trust - Xuzhou Zhongtai and Tangshan Rongfeng
On
February 17, 2014, Xi’an TCH entered into a trust loan agreement with Zhongrong International Trust Co., Ltd (“ZRIT”),
for Xi’an TCH to borrow RMB 150 million ($24.5 million) for the CDQ system and the CDQ WHPG Project with Xuzhou Zhongtai
Energy Technology Co., Ltd. (the “Zhongtai Project”). ZRIT set up a Zhongrong-Green Recycling Energy Collective Capital
Trust Plan No. 1 (the “Trust Plan No. 1”) to raise money and loan the proceeds to Xi’an TCH for the Zhongtai
Project (the “Zhongtai Loan”). The Zhongtai Loan was secured by the pledge of CDQ equipment and power generation system
of the Zhongtai Project, by personal guarantee of the Chairman and CEO of the Company, and by a corporate guarantee of Xuzhou
Zhongtai Energy Technology Co., Ltd. and its affiliated companies. As of March 31, 2017, this loan was paid in full.
On
February 17, 2014, Xi’an TCH entered into another trust loan agreement with ZRIT, for Xi’an TCH to borrow RMB 135
million ($22.1 million) for the CDQ system and the CDQ WHPG Project with Tangshan Rongfeng Iron & Steel Co., Ltd. (the “Rongfeng
Project”). ZRIT set up a Zhongrong-Green Recycling Energy Collective Capital Trust Plan No. 2 (the “Trust Plan No.
2”) to raise money and loan the proceeds to Xi’an TCH for the Rongfeng Project (the “Rongfeng Loan”).
The Rongfeng Loan was secured by the pledge of CDQ equipment and power generation system of the Rongfeng Project, by a personal
guarantee of the Chairman and CEO of the Company, and by a corporate guarantee of Tangshan Rongfeng Iron & Steel Co., Ltd.
and its parent company. On December 21, 2015, Xi’an TCH paid in full the loan for the Rongfeng Project upon the transfer
of the CDQ and a CDQ WHPG system to Rongfeng.
Summary
As
of March 31, 2017, the future minimum repayment of all the loans including the entrusted loan to be made by years is as follows:
2017
|
|
$
|
48,410,708
|
|
2018
|
|
|
289,884
|
|
Total
|
|
$
|
48,700,593
|
|
13.
REFUNDABLE DEPOSIT FROM CUSTOMERS FOR SYSTEMS LEASING
The
refundable deposit was mainly for Pucheng, Shenqiu and Yida systems. As of March 31, 2017 and December 31, 2016, the balance of
refundable deposit from customers for systems leasing was $1,029,090 for Pucheng and Shengqiu systems, and $1,023,497 for Pucheng,
Shenqiu and Yida systems, respectively.
14.
RELATED PARTY TRANSACTIONS
As
of March 31, 2017, the Company had $41,775 in advances from the Company’s management, which bear no interest, and are payable
upon demand.
On
August 27, 2014, the Company entered into a Share Purchase Agreement (the “Agreement”) with Mr. Ku. Pursuant to the
Agreement, the Company issued to Mr. Ku 1,382,908 shares of the Company’s common stock on September 5, 2014 (adjusted for
the 1:10 reverse stock split). The purchase price per share for the Shares was the average closing price quoted on the NASDAQ
Global Market for the common stock of the Company for 15 trading days prior to the effective date of the Agreement, which was
$1.37 per share. The Company received payments in two installments of $12 million and $6.91 million on September 5, 2014 and September
12, 2014, respectively, in equivalent of RMB 74.05 million and RMB 42.85 million, respectively, using the middle exchange rate
between USD and RMB published by the People’s Bank of China on the effective date of the agreement pursuant to its terms.
These shares were recorded using the fair value of $1.49 per share. The Company filed a registration statement registering the
Shares for resale on Form S-3 (Reg. No. 333-214834), which was declared effective by the Securities and Exchange Commission on
December 20, 2016.
During
the three months ended March 31, 2017, the Company recognized RMB 6.79 million ($0.99 million) interest income for the sales-type
lease of Pucheng BMPG systems from Pucheng Xin Heng Yuan Biomass Power Generation Corporation, whose major stockholder became
a stockholder of CREG through the issuance of the Company’s common stock to this stockholder in consideration for the transfer
of the old system to CREG for BMPG system transformation.
Also
during the year ended December 31, 2016, prior to repurchase date, the Company recognized RMB 13.83 million ($2.09 million) interest
income for the sales-type lease of Yida WGPG system from Qitaihe City Boli Yida Coal Selection Co., Ltd., whose major stockholder
became a stockholder of CREG through the issuance of the Company’s common stock to this stockholder in consideration for
the transfer of the old system to CREG for WGPG system transformation.
15.
NONCONTROLLING INTEREST
On
July 15, 2013, Xi’an TCH and HYREF Fund jointly established Xi’an Zhonghong New Energy Technology (“Zhonghong”)
with registered capital of RMB 30 million ($4.88 million), to manage new projects. Xi’an TCH paid RMB 27 million ($4.37
million). Xi’an TCH owns 90% of Zhonghong while HYREF Fund owns 10% of Zhonghong as non-controlling interest of Zhonghong.
In
addition, the HYREF Fund was 16.3% owned by Xi’an TCH and 1.1% owned by the Fund Management Company, and the Fund Management
Company was 40% owned by Xi’an TCH as described in Note 7, which resulted in an additional indirect ownership of Xi’an
TCH in Zhonghong of 1.7%; accordingly, the ultimate non-controlling interest (HYREF Fund) in Zhonghong became 8.3%. During the
three months ended March 31, 2017 and 2016, the Company had losses of $88,423 and $51,280 that were attributable to the noncontrolling
interest, respectively.
16.
INCOME TAX
The
Company’s Chinese subsidiaries are governed by the Income Tax Law of the PRC concerning privately-run enterprises, which
are generally subject to tax at 25% on income reported in the statutory financial statements after appropriate tax adjustments.
Under the Chinese tax law, the tax treatment of finance and sales-type leases is similar to US GAAP. However, the local tax bureau
continues to treat CREG sales-type leases as operating leases. Accordingly, the Company recorded deferred income taxes.
The
Company’s subsidiaries generate all of their net income from their PRC operations. Yinghua and Shanghai TCH’s effective
income tax rate for 2017 and 2016 was 25%. During 2013, Xi’an TCH was re-approved for high tech enterprise status and enjoyed
15% preferential income tax rate for three years effective January 1, 2013 through December 31, 2015, and is subject to 25% income
tax rate in 2016 unless the renewal of preferential income tax rate is approved by the tax authority; as of March 31, 2017, the
preferential income tax rate is not yet approved. Huahong, Zhonghong and Erdos TCH’s effective income tax rate for 2017
and 2016 was 25%. Yinghua, Shanghai TCH, Xi’an TCH, Huahong, Zhonghong and Erdos TCH file separate income tax returns.
There
is no income tax for companies domiciled in the Cayman Islands. Accordingly, the Company’s consolidated financial statements
do not present any income tax provisions related to Cayman Islands tax jurisdiction where Sifang Holding is domiciled.
The
US parent company, China Recycling Energy Corporation, is taxed in the US and, as of March 31, 2017, had net operating loss (“NOL”)
carry forwards for income taxes of $14.05 million, which may be available to reduce future years’ taxable income as NOLs
can be carried forward up to 20 years from the year the loss is incurred. Our management believes the realization of benefits
from these losses may be uncertain due to the US parent company’s continuing operating losses. Accordingly, a 100% deferred
tax asset valuation allowance was provided.
The
following table reconciles the US statutory rates to the Company’s effective tax rate for the three months ended March 31,
2017 and 2016, respectively:
|
|
2017
|
|
|
2016
|
|
U.S. statutory rates
|
|
|
34.0
|
%
|
|
|
34.0
|
%
|
Tax rate difference – current provision
|
|
|
(7.7
|
)%
|
|
|
(15.6
|
)%
|
Tax rate change for future deferred tax items
|
|
|
-
|
%
|
|
|
39.6
|
%
|
Valuation allowance on PRC NOL
|
|
|
37.9
|
%
|
|
|
0.7
|
%
|
Valuation allowance on US NOL
|
|
|
(5.0
|
)%
|
|
|
24.8
|
%
|
Tax per financial statements
|
|
|
59.3
|
%
|
|
|
83.5
|
%
|
The
provision for income taxes expense for the three months ended March 31, 2017 and 2016 consisted of the following:
|
|
2017
|
|
|
2016
|
|
Income tax expense – current
|
|
$
|
339,222
|
|
|
$
|
356,499
|
|
Income tax expense (benefit) - deferred
|
|
|
77,081
|
|
|
|
(145,728
|
)
|
Total income tax expense
|
|
$
|
416,303
|
|
|
$
|
210,771
|
|
17.
STOCK-BASED COMPENSATION PLAN
Options
to Employees
The
Company recorded no compensation expense for stock options to employees during the three months ended March 31, 2017 and 2016.
On
June 19, 2015, the stockholders of the Company approved the China Recycling Energy Corporation Omnibus Equity Plan (the “Plan”)
at its annual meeting. The total shares of common stock authorized for issuance during the term of the Plan is 12,462,605 shares
(prior to the 10:1 Reverse Stock Split). The Plan was effective immediately upon the adoption by our Board of Directors on April
24, 2015, subject to stockholder approval, and will terminate on the earliest to occur of (i) the 10th anniversary of the Plan’s
effective date, or (ii) the date on which all shares available for issuance under the Plan shall have been issued as fully-vested
shares. No share or option grants were made to employees under the Plan as of March 31, 2017.
Options
to Independent Directors
On
March 31, 2015, the Board appointed Mr. Cangsang Huang as a member of the Company’s Board of Directors to fill a vacancy.
In connection with the appointment, the Board authorized the Company to provide Mr. Huang with (i) compensation of $2,000 per
month and (ii) the grant of an option to purchase 40,000 shares of the Company’s Common Stock, par value $0.001, at an exercise
price equal of $1.02 per share, which was equal to the closing price per share of the Company’s Common Stock on March 31,
2015. Such options were only valid and exercisable upon stockholder approval. The options to Mr. Huang were not voted upon at
the Company’s annual stockholder’s meeting on June 19, 2015 and were cancelled automatically. However, the Company’s
Plan adopted by the Board on April 24, 2015 for providing equity awards to employees, directors and consultants was approved at
the annual stockholder’s meeting; accordingly, the Compensation Committee of the Board of Directors approved a grant of
40,000 options (prior to the 10:1 Reverse Stock Split) to Mr. Huang at an exercise price of $1.02 per share under the Plan, which
vested immediately on the date of grant, which was on October 10, 2015. The options may be exercised within five years of the
date of the grant.
The
following table summarizes option activity with respect to the independent directors, the number of options reflects the 10:1
Reverse Stock Split effective May 25, 2016:
|
|
Number
of
Shares
|
|
|
Average Exercise Price per
Share
|
|
|
Weighted
Average
Remaining
Contractual
Term
in Years
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at January 1, 2016
|
|
|
4,000
|
|
|
$
|
10.2
|
|
|
|
4.77
|
|
Exercisable at January 1, 2016
|
|
|
4,000
|
|
|
|
10.2
|
|
|
|
4.77
|
|
Granted
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Exercised
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Forfeited
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Outstanding at December 31, 2016
|
|
|
4,000
|
|
|
|
10.2
|
|
|
|
3.77
|
|
Exercisable at December 31, 2016
|
|
|
4,000
|
|
|
|
10.2
|
|
|
|
3.77
|
|
Granted
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Exercised
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Forfeited
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Outstanding at March 31, 2017
|
|
|
4,000
|
|
|
|
10.2
|
|
|
|
3.52
|
|
Exercisable at March 31, 2017
|
|
|
4,000
|
|
|
$
|
10.2
|
|
|
|
3.52
|
|
18.
CONTINGENCIES
The
Company’s operations in the PRC are subject to specific considerations and significant risks not typically associated with
companies in North America and Western Europe. These include risks associated with, among others, the political, economic and
legal environments and foreign currency exchange. The Company’s results may be adversely affected by changes in governmental
policies with respect to laws and regulations, anti-inflationary measures, currency conversion and remittance abroad, and rates
and methods of taxation, among other things.
The
Company’s sales, purchases and expense transactions are denominated in RMB and all of the Company’s assets and liabilities
are also denominated in RMB. The RMB is not freely convertible into foreign currencies under the current law. In China, foreign
exchange transactions are required by law to be transacted only by authorized financial institutions. Remittances in currencies
other than RMB may require certain supporting documentation in order to make the remittance.
The Company sells electricity
to its customers and receives commercial notes (bank acceptance) from them in lieu of payments for accounts receivable. The Company
discounts the commercial notes with the bank or endorses the commercial notes to vendors for payment of their own obligations
or to get cash from third parties. Most of the commercial notes have a maturity of less than six (6) months. As of March 31, 2017,
the Company had endorsed notes receivable of $724,711; at December 31, 2016, the Company had outstanding notes receivable of $0.
19.
COMMITMENTS
Lease
Commitment
On
March 4, 2014, Xi’an TCH’s office lease expired and Xi’an TCH renewed this lease for two years; the monthly
rental payment is $20,140. The lease for the office in Xi’an was renewed for two years starting on March 5, 2016 with a
monthly rental payment of $21,804 but payable quarterly in advance. In addition, on September 16, 2013, Xi’an TCH leased
an office in Beijing for a term of two-years and three-months, expiring on December 31, 2015, with a monthly rental payment of
$12,110. The lease for the office in Beijing was not renewed at expiration. For the three months ended March 31, 2017 and 2016,
the rental expense of Xi’an TCH was $59,065 and $56,726, respectively.
Future
minimum annual rental payments required under operating leases as of March 31, 2017 were as below (by year):
2018
|
|
$
|
248,075
|
|
Total
|
|
$
|
248,075
|
|
Construction
Commitment
Refer
to Note 1 for additional details related to lease commitments with Chengli, Tianyu (and its subsidiaries Xuzhou Tian’an
and Xuzhou Huayu), and Zhongtai and Note 8 for commitments on construction in progress.
20.
SUBSEQUENT EVENTS
The
Company has evaluated subsequent events that occurred subsequent to March 31, 2017, and through the date the CFS were issued as
of the date of the report. Management has concluded that no subsequent events required disclosure in these CFS.
Item 2.
Management’s
Discussion and Analysis of Financial Condition and Results of Operations
Note
Regarding Forward-Looking Statements
This
quarterly report on Form 10-Q and other reports filed by the Company from time to time with the SEC (collectively the “Filings”)
contain or may contain forward-looking statements and information that are based upon beliefs of, and information currently available
to, Company’s management as well as estimates and assumptions made by Company’s management. Readers are cautioned
not to place undue reliance on these forward-looking statements, which are only predictions and speak only as of the date hereof.
When used in the filings, the words “may”, “will”, “should”, “would”, “anticipate”,
“believe”, “estimate”, “expect”, “future”, “intend”, “plan”,
or the negative of these terms and similar expressions as they relate to Company or Company’s management identify forward-looking
statements. Such statements reflect the current view of Company with respect to future events and are subject to risks, uncertainties,
assumptions, and other factors (including the statements in the section “results of operations” below), and any
businesses that Company may acquire. Should one or more of these risks or uncertainties materialize, or should the underlying
assumptions prove incorrect, actual results may differ significantly from those anticipated, believed, estimated, expected, intended,
or planned. Factors that might cause or contribute to such a discrepancy include, but are not limited to, those listed under the
heading “Risk Factors” and those listed in our Annual Report on Form 10-K for the year ended December 31, 2016 (the
“2016 Form 10-K”). The following discussion should be read in conjunction with our Financial Statements and related
Notes thereto included elsewhere in this report and in our 2016 Form 10-K.
Although
the Company believes the expectations reflected in the forward-looking statements are based on reasonable assumptions, the Company
cannot guarantee future results, levels of activity, performance, or achievements. Except as required by applicable law, including
the securities laws of the United States, the Company does not intend to update any of the forward-looking statements to
conform these statements to actual results. Readers are urged to carefully review and consider the various disclosures made throughout
the entirety of this report, which attempts to advise interested parties of the risks and factors that may affect our business,
financial condition, results of operations, and prospects.
Our
financial statements are prepared in US Dollars and in accordance with accounting principles generally accepted in the United
States. See “Foreign Currency Translation and Comprehensive Income (Loss)” below for information concerning the exchange
rates at which Renminbi (“RMB”) were translated into US Dollars (“USD”) at various pertinent dates and
for pertinent periods.
OVERVIEW
OF BUSINESS BACKGROUND
China
Recycling Energy Corporation (the “Company” or “CREG”) was incorporated on May 8, 1980 as Boulder Brewing
Company under the laws of the State of Colorado. On September 6, 2001, the Company changed its state of incorporation to the State
of Nevada. In 2004, the Company changed its name from Boulder Brewing Company to China Digital Wireless, Inc. and on March 8,
2007, the Company again changed its name from China Digital Wireless, Inc. to its current name, China Recycling Energy Corporation.
The Company, through its subsidiaries, sells and leases energy saving systems and equipment to its customers in the People’s
Republic of China (“PRC”). Typically, the Company transfers ownership of the waste energy recycling power generating
projects to its customers at the end of each sales-type lease and provides financing to its customers for the cost of the projects
as described below.
Our
Subsidiaries
Our
business is primarily conducted through our wholly-owned subsidiaries, Sifang Holdings and Shanghai Yinghua Financial Leasing
Co., Ltd (“Yinghua”); its wholly-owned subsidiaries, Huahong New Energy Technology Co., Ltd. (“Huahong”)
and Shanghai TCH; Shanghai TCH’s wholly-owned subsidiary, Xi’an TCH Energy Technology Company, Ltd (“Xi’an
TCH”), Xi’an TCH’s wholly-owned subsidiaries, Erdos TCH Energy Saving Development Co., Ltd (“Erdos TCH”)
and Zhongxun Energy Investment (Beijing) Co., Ltd (“Zhongxun”); and Xi’an TCH’s 90% owned subsidiary,
Xi’an Zhonghong New Energy Technology Co., Ltd. Zhonghong is engaged to provide energy saving solutions and services, including
constructing, selling and leasing energy saving systems and equipment to customers, project investment, investment management,
economic information consulting, technical services, financial leasing, purchase of financial leasing assets, disposal and repair
of financial leasing assets, consulting and ensuring of financial leasing transactions.
The
Company’s current organizational chart is as follows:
CREG
Legal
Structure
Shanghai
TCH and its Subsidiaries
Shanghai TCH was established
as a foreign investment enterprise in Shanghai under the laws of the PRC on May 25, 2004 and has a registered capital of $29.80
million. Xi’an TCH was incorporated in Xi’an, Shaanxi Province under the laws of the PRC on November 8, 2007. In February
2009, Huahong was incorporated in Xi’an, Shaanxi province. Erdos TCH was incorporated in April 2009 in Erdos, Inner Mongolia
Autonomous Region. On July 19, 2013, Xi’an TCH formed Xi’an Zhonghong New Energy Technology Co., Ltd (“Zhonghong”).
Xi’an TCH owns 90% of Zhonghong, which provides energy saving solutions and services, including constructing, selling and
leasing energy saving systems and equipment to customers.
As
of March 31, 2017, Shanghai TCH, through its subsidiaries, had sales or sales-type leases with the following parties: (i) Erdos
(for five recycling waste heat power generating systems); (ii) Pucheng (for two biomass power generation (“BMPG”)
systems); and (iii) Shenqiu (for two BMPG systems).
The
Fund Management Company and the HYREF Fund
On
June 25, 2013, Xi’an TCH and Hongyuan Huifu Venture Capital Co. Ltd (“Hongyuan Huifu”) jointly established Hongyuan
Recycling Energy Investment Management Beijing Co., Ltd (the “Fund Management Company”) with registered capital of
RMB 10 million ($1.45 million). Xi’an TCH made an initial capital contribution of RMB 4 million ($650,000) and has a 40%
ownership interest in the Fund Management Company. With respect to the Fund Management Company, voting rights and dividend rights
are allocated 80% and 20% between Hongyuan Huifu and Xi’an TCH, respectively.
The Fund Management Company
is the general partner of Beijing Hongyuan Recycling Energy Investment Center, LLP (the “HYREF Fund”), a limited liability
partnership established July 18, 2013 in Beijing. The Fund Management Company made an initial capital contribution of RMB 5 million
($830,000) to the HYREF Fund. An initial amount of RMB 460 million ($75 million) was fully subscribed by all partners for the
HYREF Fund. The HYREF Fund has three limited partners: (1) China Orient Asset Management Co., Ltd., which made an initial capital
contribution of RMB 280 million ($46.67 million) to the HYREF Fund and is a preferred limited partner; (2) Hongyuan Huifu, which
made an initial capital contribution of RMB 100 million ($16.67 million) to the HYREF Fund and is an ordinary limited partner;
and (3) the Company’s wholly-owned subsidiary, Xi’an TCH, which made an initial capital contribution of RMB 75 million
($12.5 million) to the HYREF Fund and is a secondary limited partner. The term of the HYREF Fund’s partnership is six years
from the date of its establishment, expiring on July 18, 2019. The current term is four years from the date of contribution for
the preferred limited partner, and four years from the date of contribution for the ordinary limited partner. The size of the
HYREF Fund is RMB 460 million ($75 million). The HYREF Fund was formed for the purpose of investing in Xi’an Zhonghong New
Energy Technology Co., Ltd., a 90% owned subsidiary of Xi’an TCH, for the construction of two coke dry quenching (“CDQ”)
waste heat power generation (“WHPG”) stations with Jiangsu Tianyu Energy and Chemical Group Co., Ltd. (“Tianyu”)
and one CDQ WHPG station with Boxing County Chengli Gas Supply Co., Ltd. (“Chengli”).
Erdos
TCH – Joint Venture
On April 14, 2009, the Company
formed Erdos TCH as a joint venture (the “JV” or “Erdos TCH”) with Erdos Metallurgy Co., Ltd. (“Erdos”)
to recycle waste heat from Erdos’ metal refining plants to generate power and steam to be sold back to Erdos. The JV has
a term of 20 years with a total investment for the project estimated at $79 million (RMB 500 million) and an initial investment
of $17.55 million (RMB 120 million). Erdos contributed 7% of the total investment for the project, and Xi’an TCH contributed
93%. According to Xi’an TCH and Erdos’ agreement on profit distribution, Xi’an TCH and Erdos will receive 80%
and 20%, respectively, of the profit from the JV until Xi’an TCH receives the complete return of its investment. Xi’an
TCH and Erdos will then receive 60% and 40%, respectively, of the profit from the JV. On June 15, 2013, Xi’an TCH and Erdos
entered into a share transfer agreement, pursuant to which Erdos transferred and sold its 7% ownership interest in the JV to Xi’an
TCH for $1.29 million (RMB 8 million), plus certain accumulated profits as described below. Xi’an TCH paid the $1.29 million
in July 2013 and, as a result, became the sole stockholder of Erdos TCH. In addition, Xi’an TCH is required to pay Erdos
accumulated profits from inception up to June 30, 2013 in accordance with the supplementary agreement entered on August 6, 2013.
In August 2013, Xi’an TCH paid 20% of the accumulated profit (calculated under PRC GAAP) of $226,000 to Erdos. Erdos TCH
currently has two power generation systems in Phase I with a total of 18MW power capacity, and three power generation systems
in Phase II with a total of 27MW power capacity.
With
the current economic conditions in China, the government has limited and reduced production in the iron and steel industry, which
has resulted in a sharp decrease of Erdos Metallurgy Co., Ltd’s production of ferrosilicon, its revenue and cash flows,
and has made it difficult for Erdos to make the monthly minimum lease payment.
After
considering the challenging economic conditions facing Erdos, and in order to maintain the long-term cooperative relationship
between the parties, which we believe will continue to produce long-term benefits, on April 28, 2016, Erdos TCH and Erdos entered
a supplemental agreement, effective May 1, 2016. Under the supplemental agreement, Erdos TCH cancelled monthly minimum lease payments
from Erdos, and agreed to charge Erdos based on actual electricity sold at RMB 0.30 / Kwh, which such price will be adjusted annually
based on market condition.
Shenqiu
Yuneng Biomass Power Generation Projects
On
May 25, 2011, Xi’an TCH entered into a Letter of Intent with Shenqiu YuNeng Thermal Power Co., Ltd. (“Shenqiu”)
to reconstruct and transform a Thermal Power Generation System owned by Shenqiu into a 75T/H BMPG System for $3.57 million (RMB
22.5 million). The project commenced in June 2011 and was completed in the third quarter of 2011. On September 28, 2011, Xi’an
TCH entered into a Biomass Power Generation Asset Transfer Agreement with Shenqiu (the “Shenqiu Transfer Agreement”).
Pursuant to the Shenqiu Transfer Agreement, Shenqiu sold Xi’an TCH a set of 12 MW BMPG systems (after Xi’an TCH converted
the system for BMPG purposes). As consideration for the BMPG systems, Xi’an TCH paid Shenqiu $10.94 million (RMB 70 million)
in cash in three installments within six months upon the transfer of ownership of the systems. By the end of 2012, all of the
consideration was paid. On September 28, 2011, Xi’an TCH and Shenqiu also entered into a Biomass Power Generation Project
Lease Agreement (the “2011 Shenqiu Lease”). Under the 2011 Shenqiu Lease, Xi’an TCH agreed to lease a set of
12MW BMPG systems to Shenqiu at a monthly rental rate of $286,000 (RMB 1.8 million) for 11 years. Upon expiration of the 2011
Shenqiu Lease, ownership of this system will transfer from Xi’an TCH to Shenqiu at no additional cost. In connection with
the 2011 Shenqiu Lease, Shenqiu paid one month’s rent as a security deposit to Xi’an TCH, in addition to providing
personal guarantees.
On
October 8, 2012, Xi’an TCH entered into a Letter of Intent for technical reformation of Shenqiu Project Phase II with Shenqiu
for technical reformation to enlarge the capacity of the Shenqiu Project Phase I (the “Shenqiu Phase II Project”).
The technical reformation involved the construction of another 12MW BMPG system. After the reformation, the generation capacity
of the power plant increased to 24MW. The project commenced on October 25, 2012 and was completed during the first quarter of
2013. The total cost of the project was $11.1 million (RMB 68 million). On March 30, 2013, Xi’an TCH and Shenqiu entered
into a BMPG Project Lease Agreement (the “2013 Shenqiu Lease”). Under the 2013 Shenqiu Lease, Xi’an TCH agreed
to lease the second set of 12MW BMPG systems to Shenqiu for $239,000 (RMB 1.5 million) per month for 9.5 years. When the 2013
Shenqiu Lease expires, ownership of this system will transfer from Xi’an TCH to Shenqiu at no additional cost.
Pucheng
Biomass Power Generation Projects
On
September 11, 2013, Xi’an TCH entered into a BMPG Asset Transfer Agreement (the “Pucheng Transfer Agreement”)
with Pucheng Xin Heng Yuan Biomass Power Generation Corporation (“Pucheng”), a limited liability company incorporated
in China. The Pucheng Transfer Agreement provided for the sale by Pucheng to Xi’an TCH of a set of 12MW BMPG systems with
the completion of system transformation for a purchase price of RMB 100 million ($16.48 million) in the form of 8,766,547 shares
of common stock of the Company at $1.87 per share. Also on September 11, 2013, Xi’an TCH also entered into a BMPG Project
Lease Agreement with Pucheng (the “Pucheng Lease”). Under the Pucheng Lease, Xi’an TCH leases this same set
of 12MW BMPG system to Pucheng, and combines this lease with the lease for the 12MW BMPG station of Pucheng Phase I project, under
a single lease to Pucheng for RMB 3.8 million ($0.63 million) per month (the “Pucheng Phase II Project”). The term
for the consolidated lease is from September 2013 to June 2025. The lease agreement for the 12MW station from Pucheng Phase I
project terminated upon the effective date of the Pucheng Lease. The ownership of two 12 MW BMPG systems will transfer to Pucheng
at no additional charge when the Pucheng Lease expires.
Chengli
Waste Heat Power Generation Projects
On July 24, 2013,
Zhonghong entered into a Cooperative Agreement of CDQ and CDQ WHPG Project with Boxing County Chengli Gas Supply Co., Ltd. (“Chengli”).
The parties entered into a supplement agreement on July 26, 2013. Pursuant to these agreements, Zhonghong agreed to design, build
and maintain a 25 MW CDQ system and a CDQ WHPG system to supply power to Chengli, and Chengli agreed to pay energy saving fees
(the “Chengli Project”). Chengli will contract the operation of the system to a third party contractor that is mutually
agreed to by Zhonghong. In addition, Chengli will provide the land for the CDQ system and CDQ WHPG system at no cost to Zhonghong.
The term of the Agreements is for 20 years. The first 800 million watt hours generated by the Chengli Project will be charged
at RMB 0.42 ($0.068) per kWh (excluding tax); thereafter, the energy saving fee will be RMB 0.20 ($0.036) per kWh (excluding tax).
The operating time shall be based upon an average 8,000 hours annually. If the operating time is less than 8,000 hours per year
due to a reason attributable to Chengli, then time charged shall be 8,000 hours a year, and if it is less than 8,000 hours due
to a reason attributable to Zhonghong, then it shall be charged at actual operating hours. The construction of the Chengli Project
was completed in the second quarter of 2015 and the project successfully completed commissioning tests in the first quarter of
2017. The Chengli Project is now operational, but will not begin operations until the Company receives the required power generating
license, which the Company anticipates receiving in the third quarter of 2017. When operations begin, Chengli shall ensure its
coking production line works properly and that working hours for the CDQ system are at least 8,000 hours per year, and Zhonghong
shall ensure that working hours and the CDQ WHPG system will be at least 7,200 hours per year.
On
July 22, 2013, Zhonghong entered into an Engineering, Procurement and Construction (“EPC”) General Contractor Agreement
for the Boxing County Chengli Gas Supply Co., Ltd. CDQ Power Generation Project (the “Huaxin Project”) with Xi’an
Huaxin New Energy Co., Ltd. (“Huaxin”). Zhonghong, as the owner of the Huaxin Project, contracted EPC services for
a CDQ system and a 25 MW CDQ WHPG system for Chengli to Huaxin. Huaxin shall provide construction, equipment procurement, transportation,
installation and adjustment, test run, construction engineering management and other necessary services to complete the Huaxin
Project and ensure the CDQ system and CDQ WHPG system for Chengli meet the inspection and acceptance requirements and work normally.
The Huaxin Project is a turn-key project in which Huaxin is responsible for monitoring the quality, safety, duration and cost
of the Chengli Project . The total contract price is RMB 200 million ($33.34 million), which includes all materials, equipment,
labor, transportation, electricity, water, waste disposal, machinery and safety costs.
Tianyu
Waste Heat Power Generation Project
On
July 19, 2013, Zhonghong entered into a Cooperative Agreement (the “Tianyu Agreement”) for Energy Management of CDQ
and CDQ WHPG with Jiangsu Tianyu Energy and Chemical Group Co., Ltd (“Tianyu”). Pursuant to the Tianyu Agreement,
Zhonghong will design, build, operate and maintain two sets of 25 MW CDQ and CDQ WHPG systems for two subsidiaries of Tianyu –
Xuzhou Tian’an Chemical Co., Ltd (“Xuzhou Tian’an”) and Xuzhou Huayu Coking Co., Ltd (“Xuzhou Huayu”)
– to be located at Xuzhou Tian’an and Xuzhou Huayu’s respective locations (the “Tianyu Project”).
Upon completion of the Tianyu Project, Zhonghong will charge Tianyu an energy saving fee of RMB 0.534 ($0.087) per kWh (excluding
tax). The operating time will be based upon an average 8,000 hours annually for each of Xuzhou Tian’an and Xuzhou Huayu.
If the operating time is less than 8,000 hours per year due to a reason attributable to Tianyu, then time charged will be 8,000
hours a year. The construction of the Xuzhou Tian’an Project is anticipated to be completed by the third quarter of 2017.
Xuzhou Tian’an will provide the land for the CDQ and CDQ WHPG systems for free. Xuzhou Tian’an also guarantees that
it will purchase all of the power generated by the CDQ WHPG systems. The Xuzhou Huayu Project is currently on hold due to a conflict
between Xuzhou Huayu Coking Co., Ltd and local residents on certain pollution-related issues. The local government has acted in
its capacity to coordinate the resolution of this issue. The local residents were requested to move from the hygienic buffer zone
of the project location with compensatory payments from the government. Xuzhou Huayu was required to stop production and implement
technical innovations of pollution discharge including sewage treatment, dust collection, noise control, and recycling of coal
gas. Currently, some local residents have moved. Xuzhou Huayu has completed the implementation of the technical innovations of
sewage treatment, dust collection, and noice control, and expects to complete the recycling of coal gas by the end of June 2017.
Once Huayu obtains government’s acceptance and approval of the technical innovations, the project will resume.
On
July 22, 2013, Xi’an Zhonghong New Energy Technology Co., Ltd. entered into an EPC General Contractor Agreement for the
Xuzhou Tianyu Group CDQ Power Generation Project with Xi’an Huaxin New Energy Co., Ltd. (“Huaxin”). Zhonghong
as the owner of the Project contracted EPC for the two sets of CDQ and 25 MW CDQ WHPG systems for Tianyu to Huaxin—one for
Xuzhou Tian’an and one for Xuzhou Huayu. Huaxin shall provide construction, equipment procurement, transportation, installation
and adjustment, test run, construction engineering management and other necessary works to complete the Project and ensure the
CDQ and CDQ WHPG systems for Tianyu meet the inspection and acceptance requirements and work normally. The project is a turn-key
project and Huaxin is responsible for the quality, safety, duration and cost of the Project. The total contract price is RMB 400
million ($66.67 million) of which RMB 200 million ($33.34 million) is for the Xuzhou Tian’an system and RMB 200 million
is for the Xuzhou Huayu system. The price is a cover-all price, which includes but not limited to all the materials, equipment,
labor, transportation, electricity, water, waste disposal, machinery and safety matters.
Yida
Coke Oven Gas Power Generation Project
On
June 28, 2014, Xi’an TCH entered into an Asset Transfer Agreement (the “Transfer Agreement”) with Qitaihe City
Boli Yida Coal Selection Co., Ltd. (“Yida”), a limited liability company incorporated in China. The Transfer Agreement
provided for the sale to Xi’an TCH of a 15 MW coke oven WGPG station, which was converted from a 15 MW coal gangue power
generation station from Yida. As consideration for the Transfer Asset, Xi’an TCH paid to Yida RMB 115 million ($18.69 million)
in the form of the common stock shares of the Company at the average closing price per share of the Stock for the 10 trading days
prior to the closing date of the transaction (the “Shares”). The exchange rate between US Dollar and Chinese RMB in
connection with the stock issuance was the rate equal to the middle rate published by the People’s Bank of China on the
closing date of the assets transfer.
On
June 28, 2014, Xi’an TCH also entered into a Coke Oven Gas Power Generation Project Lease Agreement (the “Lease Agreement”)
with Yida. Under the Lease Agreement, Xi’an TCH leased the Transfer Asset to Yida for RMB 3 million ($0.49 million) per
month, and the term of the lease is from June 28, 2014 to June 27, 2029. Yida will also provide an RMB 3 million ($0.49 million)
security deposit (without interest) for the lease. Xi’an TCH will transfer the Transfer Asset back to Yida at no cost at
the end of the lease term.
On
June 22, 2016, Xi’an TCH entered into a Coal Oven Gas Power Generation Project Repurchase Agreement (the “Repurchase
Agreement”) with Yida. Under the Repurchase Agreement, Xi’an TCH agreed to transfer to Yida all the project assets
for RMB 112,000,000 ($16.89 million) (the “Transfer Price”) with Yida’s retention of ownership of the Shares.
Yida agreed to make the following payments: (i) the outstanding monthly leasing fees for April and May 2016 of RMB 6,000,000 ($0.90
million) to Xi’an TCH within 5 business days from the execution of the Repurchase Agreement; (ii) a payment of RMB 50,000,000
($7.54 million) of the Transfer Price to Xi’an TCH within 5 business days from the execution of the Repurchase Agreement;
and (iii) a payment of the remaining RMB 62,000,000 ($9.35 million) of the Transfer Price to Xi’an TCH within 15 business
days from the execution of the Repurchase Agreement. Under the Repurchase Agreement, ownership of the project assets was transferred
from Xi’an TCH to Yida within 3 business days after Xi’an TCH received the full Transfer Price and the outstanding
monthly leasing fees. As of December 31, 2016, Xi’an TCH had received the outstanding monthly leasing fees for April and
May 2016 of $0.90 million and the first payment of the Transfer Price in the amount of $7.54 million. On July 11, 2016, the Company
received the second payment of the Transfer Price in the amount of $9.35 million. The Company recorded a $0.42 million loss from
this transaction in 2016.
Zhongtai
WHPG Energy Management Cooperative Agreement
On
December 6, 2013, Xi’an entered into a CDQ and WHPG Energy Management Cooperative Agreement (the “Zhongtai Agreement”)
with Xuzhou Zhongtai Energy Technology Co., Ltd. (“Zhongtai”), a limited liability company incorporated in Jiangsu
Province, China.
Pursuant
to the Zhongtai Agreement, Xi’an TCH will design, build and maintain a 150 ton per hour CDQ system and a 25 MW CDQ WHPG
system (the “Project”) and sell the power to Zhongtai, and Xi’an TCH will also build a furnace to generate steam
from the waste heat of the smoke pipeline and sell the steam to Zhongtai.
The
construction period of the Project is expected to be 18 months from the date when conditions are ready for construction to begin.
Zhongtai will start to pay an energy saving fee from the date when the WHPG station passes the required 72-hour test run. The
term of payment is for 20 years. For the first 10 years of the term, Zhongtai shall pay an energy saving fee at RMB 0.534 ($0.089)
per kWh (including value added tax) for the power generated from the system. For the second 10 years of the term, Zhongtai shall
pay an energy saving fee at RMB 0.402 ($0.067) per kWh (including value added tax). During the term of the contract the energy
saving fee shall be adjusted at the same percentage as the change of local grid electricity price. Zhongtai shall also pay an
energy saving service fee for the steam supplied by Xi’an TCH at RMB 100 ($16.67) per ton (including value added tax). Zhongtai
and its parent company will provide guarantees to ensure Zhongtai will fulfill its obligations under the Agreement. Upon the completion
of the term, Xi’an TCH will transfer the systems to Zhongtai at RMB 1 ($0.16). Zhongtai shall provide waste heat to the
systems for no less than 8,000 hours per year and waste gas volume no less than 150,000 Nm3 per hour with a temperature no less
than 950°C. If these requirements are not met, the term of the Zhongtai Agreement will be extended accordingly. If Zhongtai
wants to terminate the Zhongtai Agreement early, it shall provide Xi’an TCH a 60 day notice and pay the termination fee
and compensation for the damages to Xi’an TCH according to the following formula: (i) if it is less than five years into
the term when Zhongtai requests termination, Zhongtai shall pay: Xi’an TCH’s total investment amount plus Xi’an
TCH’s annual investment return times five years minus the years in which the system has already operated; or (ii) if it
is more than five years into the term when Zhongtai requests the termination, Zhongtai shall pay Xi’an TCH’s total
investment amount minus total amortization cost (the amortization period is 10 years).
On
March 14, 2016, Xi’an TCH entered into a Xuzhou Zhongtai CDQ and Waste Heat Power Generation System Transfer Agreement (the
“Transfer Agreement”) with Zhongtai and Xi’an Huaxin New Energy Co., Ltd., a limited liability company incorporated
in China (the “Contractor”).
The Transfer Agreement provides
for the sale to Zhongtai of all the assets of the Project under construction from Xi’an TCH. Additionally, Xi’an TCH
will transfer to Zhongtai the Engineering, Procurement and Construction (“EPC”) Contract for the Project, which Xi’an
TCH had entered into with the Contractor in connection with the Project. As consideration for the transfer of the Project, Zhongtai
is to pay to Xi’an TCH an aggregate purchase price of RMB 167,360,000 (approximately $25.75 million and the “Transfer
Price”), on the following schedule: (i) RMB 50,000,000 (approximately $7.69 million) of the Transfer Price was paid within
20 business days from the execution of the Transfer Agreement; (ii) RMB 30,000,000 (approximately $4.32 million) of the Transfer
Price will be paid within 20 business days upon the completion of the construction of the Project but not later than July 30,
2016; and (iii) RMB 87,360,000 (approximately $13.44 million) of the Transfer Price will be paid before July 30, 2017. The temporary
ownership of the Project was transferred from Xi’an TCH to Zhongtai after the Xi’an TCH received the first payment
of RMB 50,000,000, and the full ownership of the Project is to be officially transferred to Zhongtai upon full payment of the
Transfer Price. The Zhongtai Agreement is to be terminated and Xi’an TCH will agree not to pursue any breach of contract
liability against the Zhongtai under the Zhongtai Agreement when Zhongtai fully pays the Transfer Price according to the terms
of the Transfer Agreement. If the Transfer Price is not fully paid on time pursuant to the Transfer Agreement, the Transfer Agreement
automatically terminates and Xi’an TCH retains ownership of the Project, and both parties would continue to possess their
respective rights and obligations according to the Zhongtai Agreement and assume the liabilities for breach of the Zhongtai Agreement.
Xuzhou Taifa Special Steel Technology Co., Ltd. (“Xuzhou Taifa”) has guaranteed the payments by Zhongtai. As of March
31, 2017, Xi’an TCH had received the first payment of $7.70 million and the second payment of $4.32 million, and had a third
payment of $13.45 million outstanding. The Company recorded a $2.82 million loss from this transaction in 2016.
Rongfeng
CDQ Power Generation Energy Management Cooperative Agreement
On
December 12, 2013, Xi’an TCH entered into a CDQ Power Generation Energy Management Cooperative Agreement with Tangshan Rongfeng
Iron & Steel Co., Ltd. (the “Rongfeng Agreement”), a limited liability company incorporated in Hebei Province,
China.
Pursuant
to the Rongfeng Agreement, Xi’an TCH will design, build and maintain a CDQ system and a CDQ WHPG system and sell the power
to Rongfeng. The construction period of the Project is expected to be eighteen (18) months after the Agreement takes effect and
from the date when conditions are ready for construction to begin.
Rongfeng
will start to pay an energy saving fee from the date when the WHPG station passes the required 72-hour test run. The term of payment
is for 20 years. For the first 10 years of the term, Rongfeng shall pay an energy saving fee at RMB 0.582 ($0.095) per kWh (including
tax) for the power generated from the system. For the second 10 years of the term, Rongfeng shall pay an energy saving fee at
RMB 0.432 ($0.071) per kWh (including tax). During the term of the contract the energy saving fee shall be adjusted at the same
percentage as the change of local grid electricity price. Rongfeng and its parent company will provide guarantees to ensure Rongfeng
will fulfill its obligations under the Rongfeng Agreement. Upon the completion of the term, Xi’an TCH will transfer the
systems to Rongfeng at RMB 1. Rongfeng shall provide waste heat to the systems for no less than 8,000 hours per year with a temperature
no less than 950°C. If these requirements are not met, the term of the Agreement will be extended accordingly. If Rongfeng
wants to terminate the Agreement early, it shall provide Xi’an TCH a 60 day notice and pay the termination fee and compensation
for the damages to Xi’an TCH according to the following formula: 1) if it is less than or equal to five years into the term
when Rongfeng requests termination, Rongfeng shall pay: Xi’an TCH’s total investment amount plus Xi’an TCH’s
average annual investment return times five years minus the years of which the system has already operated); 2) if it is more
than five years into the term when Rongfeng requests the termination, Rongfeng shall pay: Xi’an TCH’s total investment
amount minus total amortization cost (the amortization period is 10 years).
On
November 16, 2015, Xi’an TCH entered into a Transfer Agreement of CDQ and a CDQ WHPG system with Rongfeng and Xi’an
Huaxin New Energy Co., Ltd., a limited liability company incorporated in China (“Xi’an Huaxin”). The Transfer
Agreement provided for the sale to Rongfeng of the CDQ Waste Heat Power Generation Project (the “Project”) from Xi’an
TCH. Additionally, Xi’an TCH would transfer to Rongfeng the Engineering, Procurement and Construction (“EPC”)
Contract for the CDQ Waste Heat Power Generation Project which Xi’an TCH had entered into with Xi’an Huaxin in connection
with the Project. As consideration for the transfer of the Project, Rongfeng is to pay to Xi’an TCH an aggregate purchase
price of RMB 165,200,000 ($25.45 million) on the following schedule: (i) RMB 65,200,000 ($10.05 million) was paid by Rongfeng
to Xi’an TCH within 20 business days after signing the Transfer Agreement, (ii) RMB 50,000,000 ($7.70 million) was paid
by Rongfeng to Xi’an TCH within 20 business days after the Project is completed, but no later than March 31, 2016, and (iii)
RMB 50,000,000 ($7.70 million) will be paid by Rongfeng to Xi’an TCH no later than September 30, 2016. Mr. Cheng Li, the
largest stockholder of Rongfeng, has personally guaranteed the payments. The ownership of the Project was conditionally transferred
to Rongfeng within 3 business days following the initial payment of RMB 65,200,000 ($10.05 million) by Rongfeng to Xi’an
TCH, and the full ownership of the Project will be transferred to Rongfeng after it completes the entire payment pursuant to the
terms of the Transfer Agreement. As of December 31, 2015, Xi’an TCH received the first payment of $10.05 million, and on
April 6, 2016, Xi’an TCH received the second payment of $7.70 million. The Company recorded a $3.78 million loss from this
transaction in 2015. As of December 31, 2016, the Company had received payment in full of $25.45 million.
Related
Party Transactions
As
of March 31, 2017, the Company had $41,775 in advances from the Company’s management, which bear no interest, and are payable
upon demand.
On
August 27, 2014, the Company entered into a Share Purchase Agreement (the “Agreement”) with Mr. Ku. Pursuant to the
Agreement, the Company issued to Mr. Ku 1,382,908 shares of the Company’s common stock on September 5, 2014 (adjusted for
the 1:10 reverse stock split). The purchase price per share for the Shares was the average closing price quoted on the NASDAQ
Global Market for the common stock of the Company for 15 trading days prior to the effective date of the Agreement, which was
$1.37 per share. The Company received payments in two installments of $12 million and $6.91 million on September 5, 2014 and September
12, 2014, respectively, in equivalent of RMB 74.05 million and RMB 42.85 million, respectively, using the middle exchange rate
between USD and RMB published by the People’s Bank of China on the effective date of the agreement pursuant to its terms.
These shares were recorded using the fair value of $1.49 per share. The Company filed a registration statement registering the
Shares for resale on Form S-3 (Reg. No. 333-214834), which was declared effective by the Securities and Exchange Commission on
December 20, 2016.
During
the three months ended March 31, 2017, the Company recognized RMB 6.79 million ($0.99 million) interest income for sales-type
lease of Pucheng BMPG systems from Pucheng Xin Heng Yuan Biomass Power Generation Corporation, whose major stockholder became
a stockholder of CREG through the issuance of the Company’s common stock to this stockholder in consideration for the transfer
of the old system to CREG for BMPG system transformation.
Also
during 2016, prior to the repurchase date, the Company recognized RMB 13.83 million ($2.09 million) interest income for sales-type
lease of Yida WGPG system from Qitaihe City Boli Yida Coal Selection Co., Ltd., whose major stockholder became a stockholder of
CREG through the issuance of the Company’s common stock to this stockholder in consideration for the transfer of the old
system to CREG for WGPG system transformation.
Critical
Accounting Policies and Estimates
Our
management’s discussion and analysis of our financial condition and results of operations are based on our consolidated
financial statements (“CFS”), which were prepared in accordance with accounting principles generally accepted in the
United States of America (“US GAAP”). The preparation of these financial statements requires us to make estimates
and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities
at the date of the financial statements as well as the reported net sales and expenses during the reporting periods. On an ongoing
basis, we evaluate our estimates and assumptions. We base our estimates on historical experience and various other factors that
we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying
value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates
under different assumptions or conditions.
While
our significant accounting policies are more fully described in Note 2 to our CFS, we believe the following accounting policies
are the most critical to assist you in fully understanding and evaluating this management discussion and analysis.
Basis
of Presentation
These
accompanying consolidated financial statements were prepared in accordance with US GAAP and pursuant to the rules and regulations
of the SEC for financial statements.
Basis
of Consolidation
The
CFS include the accounts of CREG and, its subsidiary, Sifang Holdings and Yinghua; Sifang Holdings’ wholly-owned subsidiaries,
Huahong and Shanghai TCH; Shanghai TCH’s wholly-owned subsidiary Xi’an TCH; and Xi’an TCH’s subsidiaries,
Erdos TCH, Zhonghong, and Zhongxun. Substantially all of the Company’s revenues are derived from the operations of Shanghai
TCH and its subsidiaries, which represent substantially all of the Company’s consolidated assets and liabilities as of March
31, 2017 and December 31, 2016, respectively. All significant inter-company accounts and transactions were eliminated in consolidation.
Use
of Estimates
In
preparing the CFS, management makes estimates and assumptions that affect the reported amounts of assets and liabilities in the
balance sheets as well as revenues and expenses during the year reported. Actual results may differ from these estimates.
Concentration
of Credit Risk
Cash
includes cash on hand and demand deposits in accounts maintained within China. Balances at financial institutions within China
are not covered by insurance. The Company has not experienced any losses in such accounts.
Certain
other financial instruments, which subject the Company to concentration of credit risk, consist of accounts and other receivables.
The Company does not require collateral or other security to support these receivables. The Company conducts periodic reviews
of its customers’ financial condition and customer payment practices to minimize collection risk on accounts receivable.
The
operations of the Company are located in the PRC. Accordingly, the Company’s business, financial condition and results of
operations may be influenced by the political, economic and legal environments in the PRC.
Accounts
Receivable
As
of March 31, 2017, the Company had accounts receivable of $12,662,154 (from sale of CDQ and a CDQ WHPG system to Zhongtai). As
of December 31, 2016, the Company had accounts receivable of $12,593,340 (from sale of CDQ and a CDQ WHPG system to Zhongtai).
Interest
Receivable on Sales Type Leases
As
of March 31, 2017, the interest receivable on sales type leases was $6,450,202, mainly representing recognized but not yet collected
interest income for the Pucheng and Shenqiu systems. As of December 31, 2016, the interest receivable on sales type leases was
$4,621,491.
The Company maintains
reserves for potential credit losses on receivables. Management reviews the composition of receivables and analyzes historical
bad debts, customer concentrations, customer credit worthiness, current economic trends and changes in customer payment patterns
to evaluate the adequacy of these reserves.
P
ucheng and Shenqiu each resumed production in
April, 2017. They have committed to repaying the overdue rental fee overtime, beginning no later than the middle or the end of
May, 2017. The Shenqiu and Pucheng users have a good record of payment and have promised to repay the due amount gradually after
production resumes. Based on an evaluation of the collectability, the Company did not record any bad debt allowances at March
31, 2017 and December 31, 2016.
Revenue
Recognition
Sales-type
Leasing and Related Revenue Recognition
The
Company constructs and then leases waste energy recycling power generating projects to its customers. The Company typically transfers
ownership of the waste energy recycling power generating projects to its customers at the end of each lease. Investment in these
projects is recorded as investment in sales-type leases in accordance with “Accounting for Leases”, codified in Financial
Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 840 and its various
amendments and interpretations. The Company manufactures and constructs waste energy recycling power generating projects and finances
its customers for the costs of the projects. The sales and cost of sales are recognized at the time of sale or inception of the
lease. The investment in sales-type leases consists of the sum of the total minimum lease payments receivable less unearned interest
income and estimated executory cost. Unearned interest income is amortized to income over the lease term so as to produce a constant
periodic rate of return on the net investment in the lease. While a portion of revenue is recognized at the inception of the lease,
the cash flow from the sales-type lease occurs over the course of the lease. Revenue is net of the Value Added Tax.
Contingent
Rental Income
The
Company records the income from actual electricity usage in addition to minimum lease payment of each project as contingent rental
income in the period earned. Contingent rent is not part of minimum lease payments.
Foreign
Currency Translation and Comprehensive Income (Loss)
The
Company’s functional currency is RMB. For financial reporting purposes, RMB figures were translated into USD as the reporting
currency. Assets and liabilities are translated at the exchange rate in effect on the balance sheet date. Revenues and expenses
are translated at the average rate of exchange prevailing during the reporting period. Translation adjustments arising from the
use of different exchange rates from period to period are included as a component of stockholders’ equity as “Accumulated
other comprehensive income.” Gains and losses from foreign currency transactions are included in income. There has been
no significant fluctuation in exchange rate for the conversion of RMB to USD after the balance sheet date.
The
Company uses “Reporting Comprehensive Income” (codified in FASB ASC Topic 220). Comprehensive income is comprised
of net income and all changes to the statements of stockholders’ equity, except those due to investments by stockholders,
changes in paid-in capital and distributions to stockholders.
RESULTS
OF OPERATIONS
Comparison
of Three Months Ended March 31, 2017 and 2016
The
following table sets forth the results of our operations for the periods indicated as a percentage of net sales, certain columns
may not add due to rounding.
|
|
2017
|
|
|
2016
|
|
|
|
|
|
|
%
of Sales
|
|
|
|
|
|
%
of Sales
|
|
Sales
|
|
$
|
-
|
|
|
|
-
|
%
|
|
$
|
6,761
|
|
|
|
100
|
%
|
Sales of systems
|
|
|
-
|
|
|
|
-
|
%
|
|
|
-
|
|
|
|
-
|
%
|
Contingent rental income
|
|
|
-
|
|
|
|
-
|
%
|
|
|
6,761
|
|
|
|
100
|
%
|
Cost of sales
|
|
|
-
|
|
|
|
-
|
%
|
|
|
6,458
|
|
|
|
96
|
%
|
Cost of systems
and contingent rental income
|
|
|
-
|
|
|
|
-
|
%
|
|
|
6,458
|
|
|
|
96
|
%
|
Gross profit
|
|
|
-
|
|
|
|
-
|
%
|
|
|
303
|
|
|
|
4
|
%
|
Interest income on sales-type leases
|
|
|
2,128,016
|
|
|
|
-
|
%
|
|
|
4,881,530
|
|
|
|
72201
|
%
|
Total operating income
|
|
|
2,128,016
|
|
|
|
-
|
%
|
|
|
4,881,833
|
|
|
|
72205
|
%
|
Total operating expenses
|
|
|
(109,061
|
)
|
|
|
-
|
%
|
|
|
(491,082
|
)
|
|
|
(7263
|
)%
|
Income from operations
|
|
|
2,018,955
|
|
|
|
-
|
%
|
|
|
4,390,751
|
|
|
|
64942
|
%
|
Total non-operating expenses, net
|
|
|
(1,316,654
|
)
|
|
|
-
|
%
|
|
|
(4,138,234
|
)
|
|
|
(61207
|
)%
|
Income before income tax
|
|
|
702,301
|
|
|
|
-
|
%
|
|
|
252,517
|
|
|
|
3735
|
%
|
Income tax expense
|
|
|
416,303
|
|
|
|
-
|
%
|
|
|
210,771
|
|
|
|
3117
|
%
|
Less: net loss attributable to noncontrolling
interest
|
|
|
(88,423
|
)
|
|
|
-
|
%
|
|
|
(51,280
|
)
|
|
|
(758
|
)%
|
Net income attributable to China Recycling
Energy Corp
|
|
$
|
374,421
|
|
|
|
-
|
%
|
|
$
|
93,026
|
|
|
|
1376
|
%
|
SALES.
Total
sales for the three months ended March 31, 2017 were $0, while total sales for the comparable period of 2016 were $6,761, a decrease
of $6,761. Of the total sales, sales of systems for the three months ended March 31, 2017 and 2016 were $0. For the three months
ended March 31, 2017, the Company had contingent rental income of $0, compared to $6,761 of contingent rental income from the
usage of electricity in addition to the minimum lease payments for the comparable period in 2016. For the sales-type leases, sales
and COS are recorded at the time of the lease; in addition to sales revenue, our other major source of revenue is interest income
from the sales-type leases.
COST
OF SALES.
Cost of sales for the three months ended March 31, 2017 was $0, while our COS for the comparable period of
2016 was $6,458, a decrease of $6,458. We did not have any contingent rental income, or finish any new construction or sale any
new system, in the three months ended March 31, 2017.
GROSS
PROFIT
. Gross profit was $0 for the three months ended March 31, 2017, compared to gross profit of $303 for the comparable
period of 2016, representing a blended gross margin of 0% and 4% for the comparable periods of 2017 and 2016, respectively. The
decrease in blended gross profit margin in the three months ended March 31, 2017 was primarily due to no sales of systems or contingent
rental income for the three months ended March 31, 2017, compared to sales of systems of $0 and contingent rental income of $6,761
for the three months ended March 31, 2016.
INTEREST
INCOME ON SALES-TYPE LEASES
. Interest income on sales-type leases for the three months ended March 31, 2017 was $2.13 million,
a $2.75 million decrease from $4.89 million for the three months ended March 31, 2016. During the three months ended March 31,
2017, interest income was derived from the following nine (9) sales-type leases:
|
i.
|
Two
BMPG systems to Pucheng Phase I and II (15 and 11.9 years, respectively);
|
|
|
|
|
ii.
|
One
BMPG system to Shenqiu Phase I (11 years);
|
|
|
|
|
iii.
|
One
BMPG system to Shenqiu Phase II (9.5 years);
|
|
|
|
|
iv.
|
Five
power and steam generating systems to Erdos (20 years);
|
On
April 28, 2016, Erdos TCH and Erdos entered a supplemental agreement, effective on May 1, 2016, whereby Erdos TCH cancelled monthly
minimum lease payments from Erdos, and charges Erdos based on actual electricity sold at RMB 0.30 / Kwh. The selling price of
each Kwh will be determined annually based on market condition.
In
comparison, during the three months ended March 31, 2016, interest income was derived from the following 10 sales-type leases:
|
i.
|
Two
BMPG systems to Pucheng Phase I and II (15 and 11.9 years, respectively);
|
|
|
|
|
ii.
|
One
BMPG system to Shenqiu Phase I (11 years);
|
|
|
|
|
iii.
|
One
BMPG system to Shenqiu Phase II (9.5 years);
|
|
|
|
|
iv.
|
Five
power and steam generating systems to Erdos (20 years);
|
|
|
|
|
v.
|
One
WGPG system to Yida (15 years).
|
OPERATING
EXPENSES.
Operating expenses consisted of general and administrative expenses totaling $109,061 for the three months
ended March 31, 2017, as compared to $491,082 general and administrative expenses for the comparable period of 2016, a decrease
of $382,021 or 79%. The decrease was mainly due to decreased payroll expenses, consulting fees, office expenses, travel expenses
and entertainment expenses. These decreases in operating expenses were a result of our decreased revenue as well as the disposal
of certain power generating systems, which led to decreased employee headcount and associated expenses.
NET
NON-OPERATING EXPENSES.
Net non-operating expenses consisted of non-sales-type lease interest income, interest expenses,
loss on sale of construction in progress and miscellaneous expenses. For the three months ended March 31, 2017, net non-operating
expense was $1.32 million compared to net non-operating expense of $4.14 million for the three months ended March 31, 2016. For
the three months ended March 31, 2017, we had $36,033 interest income and $4,523 other income, but the amounts were offset by
a $1.36 million interest expense on loans. For the three months ended March 31, 2016, we had a $31,688 interest income and a $2,976
other income, but the amounts were offset by a $1.35 million interest expense and a $2.82 million loss from the sale of construction
in progress of the Tangshan Rongfeng project.
INCOME
TAX EXPENSE.
Income tax expense was $0.42 million for the three months ended March 31, 2017, an increase of $0.21 million
from $0.21 million income tax expense for the comparable period of 2016. The consolidated effective income tax rate for the three
months ended March 31, 2017 and 2016 were 59% and 83%, respectively. The increase in income tax expense in the three months ended
March 31, 2017 was mainly due to the increase of taxable income. Xi’an TCH’s income tax rate was 25% for each of 2017
and 2016 as a result of the expiration of its high-tech enterprise status.
NET
INCOME.
Net income for the three months ended March 31, 2017 was $0.37 million compared to net income of $0.09 million
for the three months ended March 31, 2016, an increase of $0.28 million. This increase in net income was mainly due to decreased
operating expenses and non-operating expenses in the three months ended March 31, 2017.
Liquidity
and Capital Resources
Comparison
of the three months ended March 31, 2017 and 2016
As of March 31, 2017, the Company
had cash and equivalents of $47.05 million, other current assets of $32.35 million, current liabilities of $55.34 million, working
capital of $24.06 million, a current ratio of 1.40:1 and a debt-to-equity ratio of 0.25:1.
The
following is a summary of cash provided by or used in each of the indicated types of activities during the three months ended
March 31, 2017 and 2016:
|
|
2017
|
|
|
2016
|
|
Cash provided by (used in):
|
|
|
|
|
|
|
Operating Activities
|
|
$
|
(818,378
|
)
|
|
$
|
7,807,195
|
|
Investing Activities
|
|
|
-
|
|
|
|
817,914
|
|
Financing Activities
|
|
|
(145,220
|
)
|
|
|
(15,944,637
|
)
|
Net cash used in
operating activities was $0.82 million during the three months ended March 31, 2017, compared to $7.81 million provided by operating
activities in the comparable period of 2016. The decrease in net cash inflow in the three months ended March 31, 2017 was mainly
due to a decrease in cash inflow from construction in progress by $23.51 million as a result of the disposal of construction in
progress of Xuzhou Zhongtai in the comparable period of 2016, an increased cash outflow for interest receivable on sales type
leases by $1.81 million, an increased cash outflow for notes receivable by $0.15 million, and a decreased cash inflow from collection
of principal on sales type leases by $1.49 million. However, the decrease in cash inflow was partially offset by a decreased cash
outflow on accounts receivable by $17.98 million and an increased cash inflow from interest payable on an entrusted loan by $1.85
million.
Net
cash provided by investing activities was $0 for the three months ended March 31, 2017, compared to net cash provided by investing
activities of $0.82 million in the comparable period of 2016. We had $0.82 million cash inflow from change in restricted cash
in the three months ended March 31, 2016.
Net cash used in
financing activities was $0.15 million for the three months ended March 31, 2017 compared to net cash used in financing activities
of $15.94 million for the three months ended March 31, 2016. The cash outflow in the three months ended March 31, 2017 came from
the $0.15 million repayment of bank loans. In comparison, during the three months ended March 31, 2016, we had $15.94 million
in repayments of bank loans.
We
believe we have sufficient cash to continue our current business through 2017 based on recurring receipts from existing sales-type
leases. As of March 31, 2017, we had five recycling WHPG systems from the Erdos projects and four BMPG systems (two for Pucheng
and two for Shenqiu), all of which generate cash flow. In addition, we have access to bank loans in case of an immediate need
for working capital. We believe we have sufficient cash resources to cover our anticipated capital expenditures in 2017. The 9
systems that are currently in operation have minimum monthly lease payments of RMB 7.72 million ($1.12 million).
We
do not believe inflation has had or will have a significant negative impact on our results of operations in 2017.
Transfers
of Cash to and from Our Subsidiaries
The
PRC has currency and capital transfer regulations that require us to comply with certain requirements for the movement of capital.
The Company is able to transfer cash (US Dollars) to its PRC subsidiaries through: (i) an investment (by increasing the Company’s
registered capital in a PRC subsidiary), or (ii) a stockholder loan. Except as described below, the Company’s subsidiaries
in the PRC have not transferred any earnings or cash to the Company to date. The Company’s business is primarily conducted
through its subsidiaries. The Company is a holding company and its material assets consist solely of the ownership interests held
in its PRC subsidiaries. The Company relies on dividends paid by its subsidiaries for its working capital and cash needs, including
the funds necessary: (i) to pay dividends or cash distributions to its stockholders, (ii) to service any debt obligations and
(iii) to pay operating expenses. As a result of PRC laws and regulations (noted below) that require annual appropriations of 10%
of after-tax income to be set aside in a general reserve fund prior to payment of dividends, the Company’s PRC subsidiaries
are restricted in that respect, as well as in others respects noted below, in their ability to transfer a portion of their net
assets to the Company as a dividend.
With
respect to transferring cash from the Company to its subsidiaries, increasing the Company’s registered capital in a PRC
subsidiary requires the pre-approval of the local commerce department, while a stockholder loan requires a filing with the state
administration of foreign exchange or its local bureau.
With
respect to the payment of dividends, we note the following:
|
1.
|
PRC
regulations currently permit the payment of dividends only out of accumulated profits, as determined in accordance with accounting
standards and PRC regulations (an in-depth description of the PRC regulations is set forth below);
|
|
2.
|
Our
PRC subsidiaries are required to set aside, at a minimum, 10% of their net income after taxes, based on PRC accounting standards,
each year as statutory surplus reserves until the cumulative amount of such reserves reaches 50% of their registered capital;
|
|
3.
|
Such
reserves may not be distributed as cash dividends;
|
|
4.
|
Our
PRC subsidiaries may also allocate a portion of their after-tax profits to fund their staff welfare and bonus funds; except
in the event of a liquidation, these funds may also not be distributed to stockholders; the Company does not participate in
a Common Welfare Fund;
|
|
5.
|
The
incurrence of debt, specifically the instruments governing such debt, may restrict a subsidiary’s ability to pay stockholder
dividends or make other cash distributions; and
|
|
6.
|
The
Company is subject to covenants and consent requirements (presently, the Company has all consents necessary).
|
If,
for the reasons noted above, our subsidiaries are unable to pay stockholder dividends and/or make other cash payments to the Company
when needed, the Company’s ability to conduct operations, make investments, engage in acquisitions, or undertake other activities
requiring working capital may be materially and adversely affected. However, our operations and business, including investment
and/or acquisitions by our subsidiaries within China, will not be affected as long as the capital is not transferred in or out
of the PRC.
PRC
Regulations
In
accordance with PRC regulations on Enterprises with Foreign Investment and their articles of association, a foreign-invested enterprise
(“FIE”) established in the PRC is required to provide statutory reserves, which are appropriated from net profit,
as reported in the FIE’s PRC statutory accounts. An FIE is required to allocate at least 10% of its annual after-tax profit
to the surplus reserve until such reserve has reached 50% of its respective registered capital (based on the FIE’s PRC statutory
accounts). The aforementioned reserves may only be used for specific purposes and may not be distributed as cash dividends. Until
such contribution of capital is satisfied, the FIE is not allowed to repatriate profits to its stockholders, unless approved by
the State Administration of Foreign Exchange. After satisfaction of this requirement, the remaining funds may be appropriated
at the discretion of the FIE’s board of directors. Our subsidiary, Shanghai TCH, qualifies as an FIE and is therefore subject
to the above-mandated regulations on distributable profits.
Additionally,
in accordance with PRC corporate law, a domestic enterprise is required to maintain a surplus reserve of at least 10% of its annual
after-tax profit until such reserve has reached 50% of its respective registered capital based on the enterprise’s PRC statutory
accounts. A domestic enterprise is also required to provide discretionary surplus reserve, at the discretion of the board of directors,
from the profits determined in accordance with the enterprise’s PRC statutory accounts. The aforementioned reserves can
only be used for specific purposes and may not be distributed as cash dividends. Xi’an TCH, Huahong, and Erdos TCH were
established as domestic enterprises; therefore, each is subject to the above-mentioned restrictions on distributable profits.
As
a result of PRC laws and regulations that require annual appropriations of 10% of after-tax income to be set aside, prior to payment
of dividends, in a general reserve fund, the Company’s PRC subsidiaries are restricted in their ability to transfer a portion
of their net assets to the Company as a dividend or otherwise.
Chart
of the Company’s Statutory Reserve
Pursuant
to PRC corporate law, effective January 1, 2006, the Company is required to maintain a statutory reserve by appropriating from
its after-tax profit before declaration or payment of dividends. The statutory reserve represents restricted retained earnings.
Our restricted and unrestricted retained earnings under US GAAP are set forth below:
|
|
As at
|
|
|
|
March 31,
2017
|
|
|
December 31,
2016
|
|
Unrestricted retained earnings
|
|
$
|
86,092,216
|
|
|
$
|
85,838,637
|
|
Restricted retained earnings (surplus reserve fund)
|
|
|
14,594,765
|
|
|
|
14,473,924
|
|
Retained earnings (including surplus reserve fund)
|
|
$
|
100,686,981
|
|
|
$
|
100,312,561
|
|
Off-Balance
Sheet Arrangements
We
have not entered into any other financial guarantees or other commitments to guarantee the payment obligations of any third parties.
We have not entered into any derivative contracts that are indexed to our shares and classified as stockholders’ equity
or that are not reflected in our consolidated financial statements. Furthermore, we do not have any retained or contingent interest
in assets transferred to an unconsolidated entity that serves as credit, liquidity or market risk support to such entity. We do
not have any variable interest in any unconsolidated entity that provides financing, liquidity, market risk or credit support
to us or engages in leasing, hedging or research and development services with us.
Contractual
Obligations
The
Company’s contractual obligations as of March 31, 2017 are as follows:
Contractual Obligation
|
|
1
year or
less
|
|
|
More
than
1
year
|
|
|
See
Note
(for
details)
|
|
Bank loans and trust loan payable
|
|
$
|
579,769
|
|
|
$
|
-
|
|
|
|
12
|
|
Entrusted loan
|
|
|
47,830,939
|
|
|
|
289,885
|
|
|
|
12
|
|
Total
|
|
$
|
48,410,708
|
|
|
$
|
289,885
|
|
|
|
|
|
The
Company believes that it has a stable cash inflow each month and a sufficient channel to commercial institutions to obtain any
loans that may be necessary to meet its working capital needs. Historically, we have been able to obtain loans or otherwise achieve
our financing objectives due to the Chinese government’s support for energy-saving businesses with stable cash inflows,
good credit ratings and history. The Company does not believe it will have difficulties related to the repayment of its outstanding
short-term loans.
Commitments
Boxing
Chengli Power Generation Projects
On
July 24, 2013, Zhonghong entered into a Cooperative Agreement of CDQ and CDQ WHPG Project with Boxing County Chengli Gas Supply
Co., Ltd. (“Chengli”), including a supplement agreement entered by the parties on July 26, 2013.
Pursuant to the agreements,
Zhonghong will design, build and maintain a CDQ system and a 25 MW CDQ WHPG system to supply power to Chengli, and Chengli will
pay energy saving fees. Chengli will contract the operation of the system to a third party contractor that is mutually agreed
to by Zhonghong. In addition, Chengli will provide the land for the CDQ and CDQ WHPG system at no cost to Zhonghong. The term
of the Agreements is 20 years. The energy saving fees generated by the Project will be charged at RMB 0.42 ($0.068) per kWh (excluding
tax). The operating time shall be based upon an average 8,000 hours annually. If the operating time is less than 8,000 hours due
to a reason attributable to Chengli’s, then time charged shall be 8,000 hours a year, and if it is less than 8,000 hours
due to a reason attributable to Zhonghong, then it shall be charged at actual operating hours. The construction of the Project
was completed in the second quarter of 2015, and the commissioning tests were successfully completed in the first quarter of 2017.
The Chengli Project is now operational, but will not begin operations until the Company receives the required power generating
license, which the Company anticipates receiving in the third quarter of 2017. From the date of the operation, Chengli shall ensure
its coking production line works properly and that working hours for the CDQ system are no less than 8,000 hours/year, while Zhonghong
shall ensure that working hours and the CDQ WHPG system will be no less than 7,200 hours/year.
On
July 22, 2013, Xi’an Zhonghong New Energy Technology Co., Ltd. entered into an EPC General Contractor Agreement for the
Boxing County Chengli Gas Supply Co., Ltd. CDQ Power Generation Project (the “Project”) with Xi’an Huaxin New
Energy Co., Ltd. (“Huaxin”). Zhonghong as the owner of the Project contracted EPC for a CDQ and a 25 MW CDQ WHPG system
for Chengli to Huaxin. Huaxin shall provide construction, equipment procurement, transportation, installation and adjustment,
test run, construction engineering management and other necessary works to complete the Project and ensure the CDQ and CDQ WHPG
system for Chengli meet the inspection and acceptance requirements and work normally. The project is a turn-key project and Huaxin
is responsible for the quality, safety, duration and cost of the Project. The total contract price is RMB 200 million ($28.83
million). The price is a cover-all price which includes but is not limited to all the materials, equipment, labor, transportation,
electricity, water, waste disposal, machinery and safety matters. As of March 31, 2017, Zhonghong had paid $24.52 million for
the project, and is committed to pay an additional $4.47 million for the Boxing project.
Xuzhou
Tian’an and Xuzhou Huayu CDQ Power Generation Projects
On
July 19, 2013, Zhonghong entered into a Cooperative Agreement for Energy Management of CDQ and CDQ WHPG Project (the “Tianyu
Project”) with Jiangsu Tianyu Energy and Chemical Group Co., Ltd. (“Tianyu”).
Pursuant
to the Tianyu Agreement, Zhonghong will design, build, operate and maintain two sets of 25 MW CDQ and CDQ WHPG systems for two
subsidiaries of Tianyu: one is for and will be located at Xuzhou Tian’an Chemical Co., Ltd and one set is for and will be
located at Xuzhou Huayu Coking Co., Ltd. Upon the completion of the Tianyu Project, Zhonghong will charge Tianyu an energy saving
service fee of RMB 0.534 ($0.088) per kWh (excluding tax). The operating time shall be based upon an average 8,000 hours annually.
If the operating time is less than 8,000 hours a year due to the reason attributable to Tianyu, then time charged shall be 8,000
hours a year. Xuzhou Tian’an will provide the land for the CDQ and CDQ WHPG systems for free. Xuzhou Tian’an also
guarantees that it will purchase all of the power generated by the CDQ WHPG systems.
On
July 22, 2013, Xi’an Zhonghong New Energy Technology Co., Ltd. entered into an EPC General Contractor Agreement for the
Xuzhou Tianyu Group CDQ Power Generation Project (the “Project”) with Xi’an Huaxin New Energy Co., Ltd. (“Huaxin”).
Zhonghong as the owner of the Project contracted EPC for the two sets of CDQ and 25 MW CDQ WHPG systems for Tianyu to Huaxin—one
for Xuzhou Tian’an and one for Xuzhou Huayu. Huaxin shall provide construction, equipment procurement, transportation, installation
and adjustment, test run, construction engineering management and other necessary works to complete the Project and ensure the
CDQ and CDQ WHPG systems for Tianyu meet the inspection and acceptance requirements and work normally. The project is a turn-key
project and Huaxin is responsible for the quality, safety, duration and cost of the Project. The total contract price is RMB 400
million ($66.67 million) of which RMB 200 million ($28.83 million) is for the Xuzhou Tian’an system and RMB 200 million
is for the Xuzhou Huayu system. The price is a cover-all price which includes but is not limited to all the materials, equipment,
labor, transportation, electricity, water, waste disposal, machinery and safety matters. As of March 31, 2017, Zhonghong had paid
$17.39 million for the Huayu project and $24.83 million for the Tian’an project and is committed to pay an additional $11.60
million for the Huayu project and $4.00 million for the Tian’an project.
Item
3. Quantitative and Qualitative Disclosures About Market Risk.
Exchange
Rate Risk
Our
operations are conducted mainly in the PRC. As such, our earnings are subject to movements in foreign currency exchange rates
when transactions are denominated in RMB, which is our functional currency. Accordingly, our operating results are affected by
changes in the exchange rate between the U.S. dollar and those currencies.
Item
4. Controls and Procedures.
Disclosure
Controls and Procedures
The
Company maintains disclosure controls and procedures which are designed to provide reasonable assurance that information required
to be disclosed in the Company’s periodic SEC reports is recorded, processed, summarized and reported within the time periods
specified in the SEC’s rules and forms, and that such information is accumulated and communicated to its principal executive
officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure. The Company’s
management, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, has evaluated the
effectiveness of the Company’s “disclosure controls and procedures,” as such term is defined in Rules 13a –
15(e) and 15d – 15(e) of the Securities Exchange Act of 1934 (“Exchange Act”) at the end of the period covered
by the report.
Based
upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of March 31, 2017, the Company’s
disclosure controls and procedures were effective to provide reasonable assurance that (i) the information required to be
disclosed by us in this Report was recorded, processed, summarized and reported within the time periods specified in the SEC’s
rules and forms, and (ii) information required to be disclosed by us in our reports that we file or submit under the Exchange
Act is accumulated and communicated to our management, including our principal executive and principal financial officers, or
persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Changes
in Internal Control Over Financial Reporting
With
the participation of the Company’s management, including its Chief Executive Officer and Chief Financial Officer, the Company
also conducted an evaluation of the Company’s internal control over financial reporting to determine whether any changes
occurred during the Company’s fiscal quarter ended as of March 31, 2017, that have materially affected, or are reasonably
likely to materially affect, the Company’s internal control over financial reporting. Based on such evaluation,
management concluded that, as of the end of the period covered by this report, there have not been any changes in the Company’s
internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act)
during the fiscal quarter to which this report relates that have materially affected, or are reasonably likely to materially affect,
the Company’s internal control over financial reporting.
Inherent
Limitations on Effectiveness of Controls
Our
management, including the Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls or
our internal control over financial reporting will prevent or detect all error and all fraud. A control system, no matter how
well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will
be met. The design of a control system must reflect the fact that there are resource constraints, and the benefits of controls
must be considered relative to their costs. Further, because of the inherent limitations in all control systems, no evaluation
of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues
and instances of fraud, if any, have been detected. The design of any system of controls is based in part on certain assumptions
about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals
under all potential future conditions. Projections of any evaluation of the effectiveness of controls to future periods are subject
to risks. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance
with policies or procedures.
PART
II - OTHER INFORMATION
Item 1.
Legal Proceedings
From
time to time we may be subject to litigation, claims and assessments that arise in the ordinary course of business. Management
believes that any liability resulting from such additional matters will not have a material adverse effect on our financial position,
results of operations or cash flows. The Company is not a party to any legal proceedings that it believes will have a material
adverse effect upon the conduct of its business or its financial position.
Item 1A.
Risk Factors
There
have been no material changes in our risk factors from those disclosed in Part I, Item 1A, of our Annual Report on Form 10-K as
of and for the year ended December 31, 2016. An investment in our common stock involves various risks. When considering an investment
in our company, you should consider carefully all of the risk factors described in our most recent Form 10-K. If any of those
risks, incorporated by reference in this Form 10-Q, occur, the market price of our shares of common stock could decline and investors
could lose all or part of their investment. These risks and uncertainties are not the only ones facing us and there may be additional
matters that we are unaware of or that we currently consider immaterial. All of these could adversely affect our business, financial
condition, results of operations and cash flows and, thus, the value of an investment in our company.
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
None.
Item 3.
Defaults Upon Senior Securities
None.
Item
4. Mine Safety Disclosures.
Not
Applicable.
Item 5.
Other Information
None.
Item 6.
Exhibits
Exhibit
Number
|
|
Description
|
31.1
|
|
Certification
of Chief Executive Officer pursuant to Rule 13a-14(a).*
|
|
|
|
31.2
|
|
Certification
of Chief Financial Officer pursuant to Rule 13a-14(a).*
|
|
|
|
32.1
|
|
Certification
of Chief Executive Officer pursuant to 18 U.S.C. Section 1350.*
|
|
|
|
32.2
|
|
Certification
of Chief Financial Officer pursuant to 18 U.S.C. Section 1350.*
|
|
|
|
101.INS
|
|
XBRL
Instance Document.*
|
|
|
|
101.SCH
|
|
XBRL
Taxonomy Extension Schema Document.*
|
|
|
|
101.CAL
|
|
XBRL
Taxonomy Extension Calculation Linkbase Document.*
|
|
|
|
101.LAB
|
|
XBRL
Taxonomy Extension Label Linkbase Document.*
|
|
|
|
101.PRE
|
|
XBRL
Taxonomy Extension Presentation Linkbase Document.*
|
|
|
|
101.DEF
|
|
XBRL
Taxonomy Definitions Linkbase Document.*
|
*
Filed herewith